It's time for the Bank of Canada to cut interest rates before it's too late

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Unlike the US Federal Reserve, the Bank of Canada is running out of excuses not to act like the proverbial deer in the crosshairs. The economy here is much weaker, fiscal policy is much less stimulative even with higher spending in the federal budget, and much more excess capacity is building up, particularly in the labor market.

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The Bank of Canada, in its most recent post-meeting press release, mentioned for the first time in years that the Canadian economy had fallen into “oversupply” and added, for good measure, that “a wide range of indicators “They suggest that labor market conditions continue to relax.” However, the central bank continues to behave as if the economy is operating in an “excess demand” environment, which makes little or no sense at the current time.

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The time for playing on the sidelines even if Powell and company drag their feet is over, and it would hardly be the first time the Bank has departed from the Fed. That said, it's reasonable to expect the Canadian dollar to remain in the sanctions box, but the country needs a currency depreciation as an antidote to the relentless loss of domestic competitiveness (which isn't exactly addressed in Tuesday's budget).

Now, let's review the Canadian Consumer Price Index (CPI) data. The headline hit 0.25 percent month after month, and we've seen benign numbers like this (or lower) every month since last September. The three-month trend is reduced to an annual rate of just one percent and the six-month pace is 1.65 percent (to the second decimal place). All of this points to a headline rate drop of 2.9 percent year over year, a far cry from the 4.4 percent trajectory a year ago.

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The core CPI (excluding food and energy) was below 0.3 percent for the fourth consecutive month. The year-on-year trend is 2.9 percent (it was 4.6 percent a year ago), with the semi-annual trend at 2.7 percent annualized and 1.9 percent quarterly. At a year-over-year rate of 2.9 per cent, headline inflation is within the Bank of Canada's target range of one per cent to three per cent, thanks to another stellar core/core price performance (also less than 0. 3 percent). month over month and at a rate of 2.9 percent year over year for the old ex-food and energy index).

By any measure, core inflation declined sharply in March. Two of the Bank of Canada's three preferred core inflation measures fell substantially.

The average CPI inflation rate cooled to 2.8 percent in March from 3 percent in February and 3.2 percent in January, light years from the 4.7 percent pace a year ago and the lowest since July 2021. The “trimmed mean” metric, which excludes more extreme moves among the various components, also moderated nicely to 3.1 percent from 3.2 percent in February, the 3rd. .4 percent in January and 4.4 percent at this time last year. And the “common” CPI measure, which helps filter out idiosyncratic changes in the ingredients that make up the CPI stew, slowed to 2.9 percent from 3.1 percent in February, 3.3 percent in January and 5.7 percent in March 2023. The slowing trajectory in all of these underlying inflation indicators is undeniable at this point.

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One index we know the Bank of Canada watches closely is called CPIX, which excludes the eight most volatile segments and indirect taxes, and this indicator came in at less than 0.2 per cent sequentially after three roughly flat monthly readings. The annual trend here has more than halved over the past year, from 4.3 percent to 2.1 percent. In other words, it hits the mark.

It is probably not well known that the main source of inflation in Canada is a product of the central bank's own policy. With rates rising so much, mortgage interest costs within the CPI have soared 25 percent over the past year. Yes, yes, the chronic apartment shortage has driven up rents 8.6 percent, but mortgage payments, which show up as inflation, have increased at three times the rate. Surreal.

Eliminate mortgage costs and guess what? Inflation in Canada is also at the 2 per cent target. So why is the official rate still at five percent? We have real GDP growth of less than one percent at an annual rate (less than one-third the pace of the United States) and real interest rates, adjusted for the true measure of core inflation, of three percent. Monetary policy is simply too tight, no matter how you slice it or slice it.

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It is not just real price data that is declining, but inflation pressures point to further moderation going forward. To repeat, this is not America. Over the past year, the number of people entering the job market almost doubled the number of people who actually got a job. If you still think we have an inflation problem on our hands, I would advise you not to share that opinion with the nearly quarter of a million people who have entered the ranks of the unemployed over the past year because they might hit you in the face: ranks that have increased 23 percent in the last 12 months. That's the math behind the total percentage point increase in the overall unemployment rate over the past year, having surpassed six percent for the first time in more than two years.

It is not only the labor market that faces greater slack, but also the product market. The industry-wide capacity utilization (CAPU) rate of 78.7 percent is at its lowest level since late 2020, when hardly anyone was complaining about inflation. Look at pre-COVID-19 levels and you'll see that this CAPU rate was at 80 per cent, the unemployment rate was 5.5 per cent and the key inflation rate CPIX, which is near and dear to the Bank of Canada , was in two. percent, a figure almost identical to the current one. But where was the official interest rate back then? Try 1.75 percent, not five percent.

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It is time for the Bank of Canada to pull its head out of the sand and act quickly to avoid a potentially destabilizing recession, provided it is not too late.

David Rosenberg is founder and president of the independent research firm Rosenberg Research & Associates Inc. To receive more insights and analysis from David Rosenberg, you can sign up for a free one-month trial on the Rosenberg Research website.

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