By Ketki Saxena
Investing.com – Next week, the Bank of Canada will make a monetary policy announcement, deciding whether the benchmark policy rate will stay at 4.5%, rise further, or (unlikely) be pared back.
While recent weeks have seen indicators of strength in the Canadian economy - most notably hotter than expected GDP last Friday, and today’s labour market data - economists at RBC (TSX:RY) are calling for the Canadian central bank to keep rates on hold (for now).
RBC’s Claire Fan and Nathan Janzen write, “The Bank of Canada likely won’t make any change to the overnight interest rate next week. After announcing a conditional pause on interest rate hikes in January, the central bank is widely expected to make a second consecutive decision to hold.”
Here’s a look at the three key indicators the Bank of Canada assesses to take a “data driven” approach to its decision-making - and why the BoC is expected to stay on its conditional pause despite a still overheated economy and historically tight labour markets.
Canadian GDP
Statistics Canada reported March 31 that Canadian GDP grew 0.5% in January, after a 0.1% drop recorded in December. As per StatCan’s “flash estimate,” GDP increased an additional 0.3% in February, on a preliminary basis.
January’s robust growth, plus the preliminary data for February shows GDP tracking at between 2.5%- 3% for Q1 2023 - well above the 0.5% quarterly growth expected by the Bank of Canada.
Labour Markets
The Canadian labour market blew past expectations in March once again, with the domestic economy adding 34,700 jobs in the month - compared to expectations for 7,500 positions forecast by economists.
The unemployment rate meanwhile held steady at 5%, while wages grew 5.3% year over year, a slight downtick from the 5.4% gain seen in February.
March marks the fourth straight month of gains in the Canadian labour market, which continue to remain historically tight despite higher interest rates trickling through the economy.
Inflation
Headline CPI dropped lower to 5.2% year over year in February, a substantial decline from January’s 5.9% reading, and a continued decline from the 8.1% peak seen in June 2022. However, much of the decline was driven by lower energy prices, which declined 0.6% on a year-over-year basis - indicating that the moderation in price pressures was due to externalities like commodity pricing rather than monetary policy.
Furthermore, core inflation remained sticky. Core CPI slowed to 4.8% year over year, a modest deceleration from January’s 4.9% reading. On a monthly basis, core CPI accelerated 0.2% above the January pace to +0.3%
Despite these more troubling trends, Fan and Janzen note that on the whole the “Cooler inflation readings have been encouraging—particularly since the softening has come even before the full effect of higher interest rates hits household purchasing power.”
Why the BoC Will Likely Keep Rates on Hold Despite an Overheated Economy and Labour Market
Fan and Janzen write “The BoC’s pause on rate hiking was driven by an expectation that growth would stall through mid-2023, and Governor Macklem said it would take an “accumulation of evidence” to the contrary for it to resume tightening”
“We Don’t think that test has been met yet, and many of the effects of last year’s aggressive increases have yet to ripple through the economy.”
They also cite the recent turmoil in the banking sector as a downside risk the BoC will want to avoid playing out in the Canadian context, noting “The recent round of financial instability is a reminder that aggressive interest rate increases over the last year could yet have unexpected consequences.
Furthermore, the Bank of Canada’s recent survey of Businesses shows that companies continue to expect slower growth - which is likely to have a knock on effect on the labour market. Fan and Janzen also note that “while supply chain constraints continue to ease, concerns remain about credit and the impact of higher interest rates on customer demand.”
On the whole, the RBC economists believe that while “Inflation (and the broader economy) are still running too hot for the BoC to actively consider cutting interest rates but staying on the sidelines for now looks like an easy decision to make.”