The growing case in financial markets for the Bank of Canada to raise interest rates again – perhaps as soon as this week – has been built on some pretty compelling economic data.
Problem is, they’re the wrong data.
Market pundits and economic commentators have taken two key economic releases in the past couple of weeks: a surprising uptick in the April inflation rate, followed by surprisingly strong first-quarter gross domestic product growth. They have concluded that the economy is drifting off the Bank of Canada’s desired course.
They know that the central bank has been using higher interest rates to cool the economy and slow inflation; they have heard the bank’s message that it is prepared to resume those hikes if the rates already in place aren’t sufficiently restrictive to achieve that end. They see the GDP and inflation numbers headed in the wrong direction, and “rate hike” seems a logical conclusion.
There are, however, a few things wrong with the way that adds up.
First, the bank has always stressed that it doesn’t get too hung up on one or two individual data points. It expects a certain degree of month-to-month volatility; it doesn’t count on the numbers marching in a straight line. It’s the broader trend that interests Bank of Canada Governor Tiff Macklem and his colleagues on the policy-setting governing council.
In the current circumstance, Mr. Macklem has been clear that it would take “an accumulation of evidence” that the inflation decline is stalling to convince the bank to resume rate hikes. A month of surprising numbers does not qualify as an accumulation.
Indeed, the bank has laid out a set of specific indicators that it is watching to make that determination. We can look at these factors, collectively, as the Bank of Canada’s dashboard of gauges to tell it whether its objective – a return to 2-per-cent inflation – is on course.
These are the components of that dashboard: services inflation, core inflation, wage growth, inflation expectations and business pricing behaviour.
With the governing council in the midst of its deliberations for Wednesday’s decision, let’s consider where these indicators stand.
Consumer price inflation on the services side of the economy stood at 4.8 per cent in April, and clearly remains a bigger problem than goods inflation, which was 4 per cent. Still, services inflation was down from 5.1 per cent in March, and has been falling steadily for six months. The April numbers maintained the downward trend.
The Bank of Canada’s two most-favoured measures of core inflation – CPI-median and CPI-trim, designed to filter out short-term noise and indicate underlying price pressures – both sat at 4.2 per cent in April. That was down from an average of 4.45 per cent in March, continuing a trend of declining core inflation that began in November.
The April labour force survey showed year-over-year average hourly wage growth of 5.2 per cent, down slightly from March’s 5.3 per cent. Wage growth has been stuck around 5 per cent for most of the past year, and it’s absolutely an inflationary worry. On the other hand, the pace of wages has moderated slightly over the past three months, perhaps a sign that it has peaked.
The Bank of Canada hasn’t issued new quarterly consumer and business surveys since early April. At that time, both short-term and long-term inflation expectations were still elevated, but had declined markedly from recent highs, especially among consumers. Still, those expectations were too high for the central bank’s liking.
Business pricing behaviour
In the bank’s first-quarter business outlook survey, businesses reported that they still expect “larger and more frequent increases in their selling prices over the next 12 months compared with before the pandemic.” However, those companies also said that they expect the size and frequency of those price changes to decline over the next year. “This suggests that firms are gradually shifting closer to their normal price-setting practices,” the report said.
In short, the dashboard gauges show one clear problem (wages), and one or two question marks, but no “accumulation of evidence.” If the bank stays true to its message, this simply doesn’t add up to an immediate rate hike.
The next rate decision after this week is on July 12 – a scant five weeks away. (Typical decisions are six or seven weeks apart.) That relatively short interval will provide the bank with a great deal more information to clarify its dashboard view.
May’s employment report, with fresh wage data, lands this Friday, just two days after the rate decision. A new set of inflation numbers arrives in late June. The bank will publish its second-quarter business and consumer surveys a few days after the inflation report.
If those numbers leave the bank still worried about the persistence of inflation pressures, then July 12 would be the date to circle for a rate increase. After that, the bank goes into summer vacation mode until the next decision on Sept. 6; if it has any doubts, Mr. Macklem and his team won’t want to head to the beach with unfinished business.
But for now, the indicators that the bank cares about most still point to wait-and-see.