Published in The Globe and Mail.
Before the release of Statistics Canada’s labour survey for November, markets were fairly evenly split between predicting a 25-basis-point cut by the Bank of Canada and a 50-basis-point cut. (A basis point is one-hundredths of a percentage point.) The increase in the unemployment rate to 6.8 per cent in November, up from 6.5 per cent in October, shifted those predictions toward 50 basis points. This is what the Bank of Canada announced Wednesday morning.
The reason that market participants were hedging their bets is that the economic data were sending mixed signals, and there is a certain elephant south of the border creating uncertainty.
We think the Bank of Canada made the right move. However, it is important to understand the challenge in making this decision because of these mixed signals. Before the employment report, for each piece of data suggesting a 25-basis-point cut was in order, another suggested 50 basis points.
A cut was coming. The rate of increase of the consumer price index accelerated to 2 per cent in October, up from 1.6 per cent in September, but it has been on a downward trend. The bank risks undershooting the 2 per cent target if it doesn’t continue to cut. The debate was how far to cut.
In addition to inflation already at target, the need for quickening the pace of the cuts was supported by the fact that gross domestic product per capita has fallen in eight of the last nine quarters. However, there were worrying signs in the inflation data.
More worrying from the Bank of Canada’s point of view were increases in measures of core inflation, which aim to strip out transitory price changes: CPI Trim rose to 2.6 per cent, up from 2.4 per cent, and CPI Median rose to 2.5 per cent, up from 2.3 per cent. The bank could easily have decided to cut by less on the basis of these numbers.
Complicating matters were revised GDP data published by Statistics Canada two weeks ago. With the revisions, annual real GDP growth from 2021 to 2023 turned out to be 0.44 percentage points higher than previously estimated. That could mean economic output is closer to full capacity than previously estimated. Any boost in spending spurred by lower rates would get us closer to inflation going back up.
However, the GDP revision was in part due to increases in business investment, which will lead the Bank of Canada to raise its estimates of what full economic capacity is. This means less upward pressure on inflation.
Drilling down into the latest GDP report, consumer spending is showing signs of rebounding, contributing 0.3 percentage points to third-quarter growth. Housing markets are also indicating renewed strength. However, despite the revisions to historical GDP, business spending on machinery and equipment decreased by 7.8 per cent last quarter, which does not bode well for future growth in output.
The labour market is also sending mixed signals. Notwithstanding the aforementioned unemployment rate uptick, the Canadian economy added 53,000 jobs in November, exceeding forecasts, and the employment rate held steady at 60.6 per cent. What this means is that while the economy is employing more people, previously discouraged workers came back into the labour force, pushing the number of those considered unemployed up as well.
Finally, the threat of 25-per-cent across-the-board tariffs from the incoming Trump administration. On the one hand, they would disrupt supply chains and production, putting upward pressure on prices. However, tariff-boosted prices on the U.S. side of the border would push Canadian exports to the United States down, hurting Canadian incomes and lowering prices on this side of the border.
The 50-basis-point cut by the bank can be interpreted as a risk management approach, getting ahead of the impact of possible major tariff increases.
At 3.25 per cent, the policy rate is now just at the upper end of the Bank of Canada’s 2.25-3.25 per cent range for the estimated neutral rate of interest – the rate compatible with inflation at 2 per cent and the economy producing at full capacity. With inflation trending down (despite the upward blip in October), and the economy still having excess productive capacity, the bank’s monetary policy is still quite restrictive. The bank will need to be cutting more to avoid a possible recession and keep inflation at target.
Jeremy Kronick is Vice-President, Economic Analysis and Strategy, and Director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute, where Steve Ambler, professor of economics at Université du Québec à Montréal, is the David Dodge Chair in Monetary Policy.
