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Summary
- May’s labour data showed further loosening with the unemployment rate rising to 6.9%. However, this data was overshadowed by hotter inflation and consumption data.
- While one-offs have mostly driven inflation higher, core inflation above 3.5% remains too hot to allow the BoC to cut further.
- Falling household savings suggest consumers are loosening their belts after many quarters of building cash buffers. Sustained consumer strength may prevent further labour market loosening.
Market Implications
- We believe the BoC will remain on hold tomorrow, with the next cut likely in July.
BoC to Stay on Hold, but Reasons Remain to Cut
Canada’s economy is difficult to read, as it depends on where you look. While we believe labour weakness alone warrants a further cut, we are cognizant of the counterarguments. Here are the highlights:
1. Labour Market Loosening
May’s employment report showed further loosening, with the unemployment rate rising further to 6.9%. There were also signs of tariffs downwardly impacting labour demand, particularly in manufacturing.
This suggests the economy remains in excess supply despite slowing immigration and the BoC’s already enacted rate cuts. The pace of job growth has slowed to just 20k/ month over the past year, while the working-age population continues to grow by 40k, suggesting further loosening is ahead.
True, labour market looseness has not translated into lower inflation yet, but the trend in wage growth remains downward, with the most recent outturns suggesting a slowdown to 3.5% YoY.
However, it would be wrong to say it is all doom and gloom. First, real wages continue to recover, which has boosted consumption (more on this soon). Second, Indeed’s real-time job vacancy data shows a stabilisation that should balance supply and demand over time.
The implication is that further loosening may risk inflation falling below their 2% target. This should ensure the BoC continues cutting, despite the pace of cuts now slowing.
2. Inflation Is Sticky
Despite a looser labour market, recent core inflation outturns have been stubbornly high. CPI Trim and Median have rebounded to 3.2% annualised on a 3m/3m basis.
The BoC looks at this from two angles. The first is that hotter inflation could suggest firms have a greater ability to raise prices, while the other suggests a supply-side decline in the economy.
Importantly, both implications prevent monetary policy from loosening further, particularly when the BoC is increasingly concerned about second-round risks from tariffs.
However, we find little evidence in the data to support either hypothesis. For instance, the breadth of inflation improved in May, while much of the upside surprise in core inflation came from Financial Services CPI, which increased at its highest monthly rate since records began. This suggests it is one-off shifts moving inflation higher rather than a more sustainable shift ahead of tariffs. Additionally, the impact of lower energy prices and a stronger CAD should help cap headline inflation and thus inflation expectations in the months ahead.
3. Consumer Rebound?
Supporting the case for a hold is the recent rebound in consumption. Importantly, the household savings rate has declined by 1.5% over the past two quarters, suggesting consumers are willing to reduce their cash buffer as price pressures ease.
Strong demand for autos (now up 7% YoY) has driven consumption. Stronger auto demand supports the case that interest rates are less restrictive, though home furnishing and furniture sales – another rate-sensitive component – remain tepid. When excluding autos, gasoline and other non-core items, retail sales are now growing above the pre-pandemic rate at 5.5% YoY.
The takeaway is that if the current pace of demand continues, it should allow labour demand to rebound and may contribute to stabilising job openings.
Ahead, we keep an eye on food services (restaurant) consumption and job vacancies as our two key data points to watch.
The punchline is that hot inflation and rebounding consumption should warrant a skip in June. We remain long CORZ5 but appreciate that the case for a 2% policy rate has softened in recent weeks.
We believed the risk of a weaker economy was greater than initially appreciated, but acknowledge trade-related or US-driven weakness will now drive the BoC to cut below its neutral band.
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