How will the Bank of Canada react to a surging labour market?

October's employment report could have a big impact on the central bank's plan for further hikes

How will the Bank of Canada react to a surging labour market?

It was a bombshell report that few saw coming: the national statistics agency’s revelation last week that Canada’s economy added 108,000 jobs in October, an unexpected surge 10 times higher than economists had predicted and one that raised further questions about how high the Bank of Canada will now go on interest rates.

The central bank’s aggressive action on its benchmark rate in 2022 has been undertaken with inflation squarely in its sights, with a series of rate hikes totalling 3.5% aimed at cooling Canada’s overheated economy and ramping down runaway price growth.

It was an approach that appeared to be working, with inflation creeping down from a 40-year high in recent months and a smaller October hike than had been expected (50 basis points, rather than the anticipated 75) seemingly indicating the Bank was confident rate increases were having their desired impact.

However, Statistics Canada’s announcement – a “blowout report” in the words of TD economist Rishi Sondhi – pointed to an economy that remains resilient despite the Bank’s best efforts, with BMO’s Doug Porter describing it as a development that “[raises] serious doubts over the extent of any economic slowdown.”

Resolute jobs numbers could have a big impact on central banks’ future interest rate decisions, according to Avison Young chief economist Nick Axford (pictured top), who told Canadian Mortgage Professional that wage price growth remained a foremost concern for central bankers.

Read more: Canada sees huge October jobs surge

“Quite apart from the fact that [central banks] always hated having zero or near-zero interest rates anyway and have been desperate to try and get interest rates back into that 2-3% range where they feel much more comfortable, the longer-term battle they’re fighting is around preventing a wage price spiral – the kind of thing that we saw in the 1970s,” he said.

“Now, the world is a very different place to the 1970s, but at the same time in most parts of the world we’ve already seen increased wage expectations, increased wage costs, strikes and industrial action coming through, and we’ve seen medium-term inflation expectations starting to push up – and that’s what really concerns the banks.”

While some of those medium-term expectations are starting to come down again, at least partly because of the effect of rate hikes, the tight labour market is playing its part in that upward pressure, Axford said, resulting in higher demand for wage increases – precisely what central banks are trying to avoid.

“No-one’s really got an interest in reducing the level of GDP, but actually getting some softening into the labour market is implicitly a key part of what the central banks are looking for,” he said.

Read next: Where will interest rates go if inflation stays high in 2023?

“So they’re going to be looking at the dual indicators of actual levels of unemployment and vacancies in the job market – they’re going to want to see some softening there, but also looking at what’s coming through in terms of wage settlements and wage expectations, because those are the two key parts for the longer-term trajectory for inflation.”

Impact on real estate

The fact that there’s still little clarity around where central banks’ terminal rates will eventually end up is causing “quite a lot of uncertainty” from a real estate perspective, according to Axford, with observers unsure how many further hikes will be required.

That’s partly because individuals who are looking to put funding in place may not know what the underlying financing environment is going to look like – and while he said Canada remained the only major market that could see rate cuts in 2023, that possibility depends on numerous things panning out that “are far from certain elsewhere.”

“Whatever direction you’re coming from, whether you’re looking to put money in the market and wondering how you’re going to finance the acquisition or whether you’re thinking on the other side of the coin, ‘How bad are things going to get, what’s that going to do to pricing, and therefore what opportunities might be coming through down the road?’ clearly that uncertainty adds risk,” he said.

“Risk pushes up the return that people are expecting and given that the income side that everything’s valued off generally isn’t moving up at the moment, that means that values are coming down.”