Inflation and the labour market: Are they trending in the right direction?

The latest figures were released yesterday

Inflation and the labour market: Are they trending in the right direction?

The Bank of Canada will be keeping a close eye on the national statistics agency’s upcoming report on annual inflation, due to arrive this morning.

Statistics Canada’s monthly update, which tracks year-over-year price growth across a range of key areas, has been trending in the right direction for the central bank in recent months – although inflation remains significantly above the Bank’s target rate of 2%.

Surging price growth over the past year has prompted the Bank to introduce a series of rate increases starting last March in an effort to put the brakes on the economy and cool consumer spending.

The strategy has proven largely effective, with inflation having fallen by almost 4% at last reading compared with the 39-year high it reached last summer – but the continued resilience of the labour market could be an indication that the economy is still operating at a brisker clip than the Bank envisaged.

Over 41,000 jobs were added to the Canadian economy in April, more than double the figure anticipated by market observers polled by Bloomberg in the buildup to the announcement.

 That’s potentially significant because the central bank has made clear in recent interest rate announcements that while it’s ready to hold rates where they are for now, it’s also prepared to hike further if economic trends don’t pan out as expected.

Is the labour market presenting a problem for the Bank of Canada?

The labour markets in Canada and the United States have proven “frustratingly resilient, in some ways” and much more robust than many expected in the face of recent monetary policy tightening, according to a leading economist.

Ryan Berlin, director of intelligence and senior economist at real estate company rennie, told Canadian Mortgage Professional that with unemployment remaining near record lows in Canada, annual wage growth had been slightly higher than normal.

“Canada’s unemployment rate has been a flat 5.0% since December, which is a historical low, and so that seems to be the floor for unemployment in Canada. It’s staying there for the time being and it’s translated a little bit into wages,” he said.

“I think year-over-year increases in wages, looking at around 4%, [are] definitely higher than what you would see in a lower inflation environment when you see wages increasing by 2.5% to 3%.”

While higher wages are not having a huge effect on inflation, the still-strong labour market is complicating things “to an extent,” Berlin said, with the Bank of Canada hoping to see further softening and a hiring slump.

“I think that’s what they’re looking for – to assure themselves that we’ve hit a terminal rate, that interest rates don’t need to go higher and we can eventually start talking bout them coming lower,” he said.

The Bank has said in statements accompanying its recent rate decisions that it expects the overall inflation rate to have fallen to 3% by the middle of this year before returning to its 2% target rate in 2024.

Is a rate hike – or a rate cut – on the way in Canada?

As for the question of what trajectory the Bank will take on interest rates in the coming months? Berlin said rate cuts are certainly in the cards, although not imminent.

“This is what we know: This is not an equilibrium, or neutral interest rate, that [the Bank of Canada] has adopted,” he said. “So the question is: How do you come down from here? There’s nothing I see that would accelerate inflation at this point, so unless core inflation becomes extremely sticky and doesn’t budge from 4-5%, I’d be surprised if there’s a rate hike.”

There are plenty of economic headwinds that could still influence the Bank’s rate path, not least in the mortgage market with many borrowers set to renew on much higher interest rates than those that prevailed when they took out their mortgage in the first place.

While Berlin emphasized that nothing is certain, he said there could be room for some downward movement on rates before the end of 2023.

“I still think there’s scope for a bit of a climbdown towards the end of the year for the central bank,” he said. “But this is the big asterisk: everything is just being guided by the data, and this dynamic of a data point being released: What does it mean? Where does it fit in?

“That’s where we’re at right now. We’re just one foot in front of the other, staring down at our toes.”

 Make sure to get all the latest news to your inbox on Canada’s mortgage and housing markets by signing up for our free daily newsletter here.