Will spring bring a thaw in BoC's hawkish rate freeze?

Deloitte chief economist walks through firm's 2024 rate-cutting base case for Canadian central bank

Will spring bring a thaw in BoC's hawkish rate freeze?

Canadian consumers and business owners hoping for lower debt costs could see those wishes granted this spring.

That’s according to a newly published economic outlook report from Deloitte Canada titled “Weathering a freeze before the thaw,” which lays out the firm’s baseline forecast of Bank of Canada policymakers being in position to ease rates starting this spring.

“We see the economy slowing,” Dawn Desjardins, chief economist at Deloitte Canada (pictured above), said in an interview with Wealth Professional. “In the third quarter, we had a negative print for GDP – the momentum in the economy is quite slow. And we think that's going to persist in the early part of 2024.”

While the Canadian economy started 2023 out of balance, with excess demand relative to supply, Desjardins says the pendulum is swinging. With demand softening compared to supply, inflation is starting to ease, and she anticipates that downward pressure to continue over time.

Two keys to a dovish BoC turn

Consumers across Canada are already seeing some good news. Inflation is moving lower in the Great White North, with headline CPI coming in at 3.1% in December – significantly down from its multi-decade peak of 8.1% in the summer of 2022, but still above the BoC’s 2% target.

“The Bank of Canada has stated that inflation doesn't have to be at 2%, for them to start to lower the policy rate, but they have to have a glide path for inflation to hit that target in their sights,” Desjardins says. “We think that that is going to be very much the case as we go through the second quarter of 2024.”

There are two key pieces to Deloitte’s base-case scenario for spring rate cuts. First, Desjardins says Canada’s central bank must see a continued weakening in the Canadian economy.

Signs of that are already showing in the economic tea leaves. Apart from last week’s labour force survey showing Canada added just 100 jobs in December, the Office of the Superintendent for Bankruptcy yesterday published data from November hilghlighting a continued rising trend of consumer and business insolvencies.

“If the economy proves to be much more resilient – if we start to see evidence of strong consumer spending – I think the Bank of Canada would take that into account and pause,” Desjardins says.

The second part of the rate-reduction equation, Desjardins says, hinges on a continued slowdown in inflation, including lower expectations of price increases. But surveys in late 2023 have shown consistent price pessimism among Canadians, with both consumers and businesses thinking inflation rates will run higher than 2%.

“Shelter costs are really a strong component of what's keeping inflation elevated, whether it's the mortgage interest costs – which are running at close to 30% year-over-year – or rents which have also been running with a high rate of price inflation,” she says. “This could keep consumers’ inflation expectations elevated.”

From Desjardins’ observations, however, daily necessities like food tend to have a stronger influence on price expectations over time. Even as the figures from the federal government show a trend of easing in headline inflation as well as food price movements, she argues people’s everyday pain at the till starkly colours their perception.

“We have seen food prices still running with a positive rate of inflation, but nowhere near the peak where it was before,” she says.

From skyrocketing rates to a slow descent

As consumers and businesses start to see more evidence of easing inflation pressures, Deloitte expects their inflation expectations will brighten, opening the door for the BoC to lower their policy rate.

But while the central bank took a pedal-to-the-metal approach in tightening monetary policy, Desjardins says BoC Governor Tiff Macklem will probably want to take a slower pace as it comes back down from the mountaintop.

“To the extent that they do start to lower the policy rate in the second quarter, I think they’ll be concerned about the possibility of a really substantive and rapid increase in activity and seeing inflation pressures start to go back up,” she says. “In order to avoid that, we do think that the bank is going to be deliberate and cautious in terms of lowering their policy rates … perhaps slower than typically would be expected in a cycle.”

Assuming Canada’s economy slows down and inflation decelerates – or even better, start to accelerate to the downside – Deloitte Canada projects three rate cuts from the BoC before the year ends.

“Could they move a little more rapidly? Sure,” she says. “But again, I think they want to play this slow because they don't want the economy to spark back really rapidly and inflation pressures start to rebuild.”