G10 | Monetary Policy & Inflation | Rates
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Summary
- The BoC wants strong growth to absorb labour market slack.
- However, Q3 GDP growth could be nearer 1.6%, while core inflation may also undershoot in both Q3 and Q4 by 10bps.
- The BoC will likely look through October’s unemployment report given the hiring outlook remains weak.
Market Implications
- We expect the BoC to cut 50bps tomorrow.
- We remain long Corra M5 and long the Corra Z5Z6 Steepener.
BoC Has Focused More on Excess Supply in Recent Months
The BoC’s view of the world is clear. It believes excess supply in the economy continues to dampen inflation. This has allowed it to cut three times to 4.25%. Importantly, the BoC wants faster growth to boost hiring and reduce labour market slack.
During BoC Governor Tiff Macklem’s Q&A following the September meeting, he added downside risks in growth or inflation data could warrant faster rate cuts. Then, on 24 September, Macklem suggested growth has been weaker than expected.
According to the BoC’s framework, we expect a 50bp cut tomorrow.
Examining the Case for 50bp
Since the September meeting, mostly dovish data (relative to BoC forecasts) has leaned towards faster cuts.
Growth
In July, the BoC expected quarterly GDP growth to bounce back towards 2.8% QoQ SaaR. However, the data has since leaned dovish. The Canadian economy grew 0.2% over July and August, while other data including retail sales has also been soft. Therefore, we estimate Q3 growth is nearer 1.6% (Chart 1).
Inflation
Headline inflation was expected to slow to 2.3%, but lower oil and transportation prices have resulted in a 30bps undershoot (Chart 2).
More importantly, the BoC’s measure of core inflation has fallen to 2.4% YoY in Q3, versus a forecast of 2.5%. Assuming the YTD trajectory of price increases continues (0.17% MoM), core will fall further to 2.3% YoY in Q4 or 10bps below the BoC’s forecast (Chart 3).
Shelter costs also saw progress in last month’s inflation data. The two main components are mortgage interest costs and rents – both appear to be slowing. Further progress is expected by the end of 2024 and into 2025.
Other key service components slowed too, such as restaurant prices (food away from home). Further progress here will increase BoC confidence that upside risks to inflation have diminished (Chart 4).
Employment
The big surprise since last meeting was employment data. Headline data was strong, with the economy adding 47k jobs of which 112k were full-time. Also, the unemployment rate (UR) unexpectedly declined to 6.5% as the labour force participation rate fell further to 64.9%.
The BoC is likely to view the labour market through the following lenses:
- October’s employment report partly reverses the September weakness when UR increased 20bps to 6.6%.
- Slack persists despite the surprise drop in UR, as shown by the recent BoC survey where reports of worker shortages are low.
- Indications of future hiring remain weak. Indeed data suggests a further decline in job openings, while small businesses do not suggest increasing hiring plans. This could be driving the decline in the labour force participation rate.
Therefore, aside from October’s pick-up in full-time employment, most other indicators point towards the BoC cutting 50 bps.
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(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)