Bank of Canada held its target for the overnight rate at 5%

It was widely expected that the Bank of Canada announcement this morning would leave its interest rate unchanged. The main reason economists and any of us watching were looking forward to today’s announcement is to see what kinds of clues that the Bank of Canada was going to leave us in the announcement.

We know that the Bank of Canada has been concerned over the last couple of years about the high level of inflation here in Canada, really wanting to get that inflation number back down to about 2%. It hasn’t gotten there yet. The primary reason the Bank of Canada increased its interest rate all the way from almost zero all the way up to 5% since the beginning of 2022 was to combat inflation and inflation peaked at around 10% in mid-2022. Thankfully it has been decreasing ever since, but not every single month.

Twice in the last year we have seen inflation under 3% both in June and January. Meanwhile, we wait for that interest rate to come back down to the 2% mark that is the target, which allows for price stability for Canadians all across the board. Thankfully, we have been seeing some prices come down and grocery stores aren’t as expensive with many of the items but certainly not everything.

The Bank of Canada gave us a really, really solid hint today in its announcement. It says,  “Employment continues to grow more slowly than the population.” Well, of course, we never are excited about people not having jobs, but from an inflationary perspective that a positive thing. The Bank points out that “there are now some signs that wage pressures may be easing.”

Productivity levels per hour worked actually increased in Canada for the first time in a long time. So productivity compared to wages is actually improving, and that’s a good thing as well. There are many reasons that the Bank of Canada can be expected to start to decrease its interest rate soon.

Mortgage Interest Cost is problem

The first is, if we remove mortgage interest costs from the inflation numbers, we’re actually already at 2% as shown on this image. The darker blue line is the headline, CPI or Consumer Price Index inflation numbers and the teal line is the same thing but with the mortgage interest extracted.

When inflation was starting to go up, mortgage interest was actually pulling it down. It was reducing the inflation in the market. But now it’s doing the opposite. If we zoom in really close at the last couple of months what’s happening, you can see that in the January inflation number it came in at 2.9 percent which is the darker blue line but if we extract or remove mortgage interest costs from it, it’s actually pretty much at the 2 percent mark. Mortgage interest costs, which are directly attributable to the Bank of Canada’s policy of raising the interest rates and monetary tightening are a lot of the current inflation. As the interest rates do start to decrease both on the fixed side as well as the Bank of Canada side, what we’re going to find is that inflation is really just going to start to normalize back down to that 2% as long as things continue.

GDP Per Person is DECREASING

Another thing that is worth noting is GDP. GDP is the size of the economy and we measure growth. In first world economics we want to see economies growing every single quarter. If economies shrink two quarters in a row, then that’s the technical definition of a recession. Canada as a whole, its GDP or economy size has been growing, but the rate of growth has been slowing.

Post-COVID, there was a big spike to sort of offset the big drop at the beginning of COVID, but then it’s normalized actually a lot closer to zero. This has been raising a lot of concern for economists and analysts alike. There was a slight uptick from just under half of a percent to just under 1% in the last quarter of 2023. This is a positive sign.

If we peel back the layers and look at this relative to some additional data, you’re going to see that population growth has been accelerating in Canada. It had a big slowdown during COVID, and maybe it’s just we’re catching up to that, but population growth has now exceeded 3%. Our population is growing faster than our economy. If we tear down and look at the economy on a per-person basis, it’s actually shrinking. And that’s not something that we want to see.

This is something that is going to be impacting the Bank of Canada’s decisioning and how they’re choosing to proceed and of course it is going to have some negative impact on our inflation. We can probably expect inflation to stay steady and maybe decrease a little bit which lines up with what the Bank of Canada’s expectation is.

If we take a look at what National Bank has said, they’re saying with the economy operating below potential, there are clear signs that the tighter monetary policy, that’s the higher interest rates, is working. However, above target inflation and sticky wage pressures will leave the Bank of Canada unwilling to consider very quick rate drops. However, in today’s announcement, a few days after this National Bank statement was released, the Bank of Canada did say that they’re less concerned about wage increases and you know if we strip out mortgage interest then inflation isn’t as bad.

So where does that leave us? When can we expect mortgage rates, specifically the Bank of Canada rate, to start to decrease? Well, the general consensus across many, many economists is that it will happen two rate announcements from now. June 5, 2024. Look forward to a quarter percent interest rate drop in June. There’s a high degree of expectation that we’re going to see before the end of December, probably three more quarter percent interest rate drops and more as 2025 begins. So there is relief in sight.

We’re going to start to see variable rates come down. We’re already seeing fixed interest rates decreasing and so that does change some of the conversation around what kind of mortgage should you be looking at.