Higher-than-expected inflation means we're not at the point of a central bank cut just yet
Canada’s higher-than-expected consumer price index in November has stymied, somewhat, the idea that the Bank of Canada might take a dovish turn very early in 2024. CPI came in at a 3.1 per cent annualized rate, while analysts predicted 2.9 per cent. While the gap may seem marginal, the fact that inflation is not falling as fast as expected can be taken along with recent quasi-hawkish comments by BoC Governor Tiff Macklem as signs that the predicted BoC cut in 2024 may not come as soon as many investors expect.
Brooke Thackray, research analyst at Horizons ETFs, noted that investors are looking for inflation to fall below 3 per cent to know that the battle against inflation has been won and the BoC can begin to cut rates. He thinks that despite slowing growth in the economy, and a likely short dip into a recession in 2024, the road to cuts may be slower and more difficult than we have expected.
“The takeaway is that it’s going to be a bit of a longer process. I think the Bank of Canada doesn’t want to get ahead of themselves and say ‘let’s start taking action now,’ while inflation rates still maintain the 3 handle, I think that would make them look bad in the end,” Thackray says. “Macklem hasn’t followed [Federal Reserve Chair Jerome] Powell, as far as rhetoric goes. He’s still talking about tightening.”
Thackray continues to believe that we will not see another interest rate hike from the BoC. However, he does highlight that while Powell has already made a dovish pivot in his language and began outlining the potential for rate cuts next year, Macklem has made no such commitment. Thackray expects that it will take at least two quarters of negative GDP growth — a technical recession — to prompt a rate cut.
As much as investors want to be able to draw a clear trend line and show a continued slowdown in the pace of inflation, Thackray notes that is not quite yet the case. After a relatively rapid fall in inflation following central bank interest rate hikes, it seems like CPI is now somewhat stagnant. Thackray explains that as a product of the lag that comes in any hiking cycle, as well as the psychology of corporate behaviour as they continue to build in price premiums to offset the potential for rising costs. He expects that the remaining fall in inflation will occur more gradually as we hit price stability.
Despite the potential impact of this CPI print, Thackray does expect interest rate cuts to come from the BoC next year. As GDP growth slows, or continues to be negative, and we see some move in unemployment higher than current levels he thinks the central bank will have to cut, likely in late spring or early summer.
Thackray’s economic outlook remains intact as well. He typifies GDP numbers as ‘lumpy’ with headline numbers oscillating between slow growth and negative growth. He thinks that the continued fight with inflation will put the economy into slow growth mode and that investors should be cautious to the downside. He predicts unemployment will rise and inflation will slow gradually as a result of currently-high interest rates. When that occurs there will be some reprieve for the Bank of Canada and they will cut interest rate slightly. Thackray does not expect a soft landing, though, and thinks that we may see some significant contractions in the economy for periods, despite aggregating out to a year of slower growth.
Looking at the news, Thackray believes advisors need to be providing appropriate context and preparedness for their clients. They need to know that inflation will continue to be a story next year and, even once it’s tamed, prices won’t necessarily be moving lower.
“We all have this natural tendency to think ‘inflation is coming down, so prices should be coming down too,’ but they stay high, and we get upset. The message to advisors is that this is a longer process than what most people are expecting at this point, and there’s not going to be a rapid relief at all,” Thackray says. “I think it’s going to be a systematic slowdown, because the Bank of Canada is trying to slow the economy down. We have a recency bias to assume that because interest rates went up very rapidly, they will go down very rapidly. But if rates come down really fast, like a lot of people are expecting, that means the economy is really in trouble, and we don’t want that.”
