This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
Summary
- Canada’s economy has averaged 6k monthly job losses recently, while the unemployment rate is up to 7.1%.
- Combined with cooler core inflation data, the BoC can resume focus on the labour market to prevent further loosening.
Market Implications
- We expect the BoC to cut 25bp on Wednesday.
- We think material risk exists of a further cut this year, though the market has now priced this in.
Data to Force Macklem to Focus on Labour Market Risks
We think the BoC will cut by 25bp on Wednesday.
The BoC has been in their words ‘assessing the downside risks to growth, against the upside risks to inflation’. Inflation concern dominated the last two meetings, while broader data painted a more benign picture of the economy.
Since then, the labour market has shown more signs of weakness, while core inflation has cooled. The economy is now shedding on average 6k jobs a month, far below the required breakeven rate of +30k. Slower gains were also seen outside the goods sector, which faced much of the brunt until July, as hiring within finance, education, and support services have all slowed. Importantly, the unemployment rate increased to 7.1% in August and is now up 50bp this year. Recall in January, Governor Macklem expressed a desire to see falling slack within the labour market. Instead, the opposite has occurred.
True, the Trump administration has continued maintaining a hawkish stance on trade, which is likely to continue in coming months as the US begins public consultations on renegotiating the USMCA. Meanwhile, Canadian exports to the US have also sagged after Q1’s frontloading, contributing to slower growth.
This has been a difficult time to set monetary policy.
Making the job harder were the erratic inflation data. In June, the three-month annualised reading for BoC core inflation rose to above 3%, while breadth also deteriorated. Currently, the picture is more favourable as core inflation has cooled as the three-month annualised rate of core inflation has cooled to 2.45% (back where we think the underlying rate is). Canada’s government has also dropped most of the retaliatory tariffs imposed on the US, easing concerns around future price increases. True, Macklem highlighted that firms face increased cost pressures from sourcing new supply chains and finding new markets, but these costs are not yet evident in the data.
Finally, as of the last meeting, the economy fell back to excess supply as the negative output gap has increased to a midpoint of -0.75% from -0.5% in Q1. These factors make a cut at this week’s BoC meeting a straightforward decision.
More tricky is the path ahead.
First, we do not believe the BoC will want to pre-guide towards further cuts. Instead, there will be a preference to maintain optionality. This is because the BoC is less able to influence the goods side of the economy (where most of the weakness lies), limiting monetary policy’s efficacy.
Second, the BoC’s evolving view of the supply side will be key. As Macklem has suggested, the BoC thinks supply-side growth is expected to slow due to US tariffs and the known slowing in the population, so even slow growth can shrink the output gap. Therefore, there must be a supply- and demand-side case for further cuts.
Lastly, while core inflation has cooled, headline inflation continues rising on food and durable goods prices. While this has a global component to it, the BoC is likely to remain more focused on these areas while inflation remains above target.
At 2.25%, the BoC will set rates at the lower end of their neutral band. While nothing prevents the BoC cutting below this level, it is unclear whether the data currently warrants it, particularly as consumers are spending again. This means CORZ5’s pricing of around 2.375%, i.e., a roughly 50% chance of another cut this year, is fair.
