Bank of Canada expected to cut rates as economy softens

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Economists widely expect the Bank of Canada to cut its policy rate for the second consecutive time on Wednesday after data released the past month suggested the Canadian economy is feeling the pinch of higher rates.

“I think the bank is going to cut again,” said Jeremy Kronick, director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute. “I think if you look the evidence that’s come since they made the announcement to cut in June, I think it’s pretty indicative of a softening economy.”

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The unemployment rate jumped to 6.4 per cent in June, discretionary consumer spending continues to decline and retail trade data released on Friday showed a decrease of 0.8 per cent compared to the month before, with sales down in eight of the nine subsectors.

“Things are fairly contained, and you can see how the lack of affordability is pinching,” said Jimmy Jean, chief economist at Desjardins Group. “You take all this together and it’s clear this is an economy that is still struggling and that’s really what the Bank of Canada wants to confirm.”

The inflation rate unexpectedly ticked up to 2.9 per cent in May, before easing down in June to 2.7 per cent. Core inflation, the measures the central bank prefers to assess when making its monetary policy decisions, ticked down last month, but the three-month annualized average jumped slightly.

Some components in the inflation basket remain sticky, including the cost of services, which grew by 4.8 per cent year-over-year in June, up from 4.6 per cent reported in May. This acceleration was driven mainly by wage growth, which is expected to decline.

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“Wages are still looking overheated, but in line with what the bank’s Business Outlook Survey showed, they should cool next year in a lagged response to softer inflation and labour market slack,” wrote Avery Shenfeld, chief economist at the Canadian Imperial Bank of Commerce, in a note to clients.

Shelter costs also remain the biggest contributor to inflation. Inflation in mortgage interest costs came in at 22.3 per cent year-over-year in June and rental costs stood at 8.8 per cent the same month.

Last month, Bank of Canada governor Tiff Macklem said Canada’s economy is headed for a “soft landing.” The bank expects Canada’s economy to grow by 1.5 per cent this year, according to its forecast in April.

However, the Royal Bank of Canada reported GDP-per-capita has been in decline in six of the past seven quarters, with the Canadian economy not keeping up with the surge in population over the past two years.

“I see this as a very atypical slowdown situation and the sequence of contractions in domestic demand per capita, we haven’t seen anything like that since the 1980s,” Jean said. “A soft landing at perhaps face value, but when you dig down things look like a mild recession to me.”

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Still, upside risks remain for the Bank of Canada to consider, with the upcoming elections in Europe and the United States, where promises of trade protectionism and de-globalization may take centre stage.

“The challenge there for the bank, is you don’t want to keep rates elevated entering those kinds of challenges, you don’t want a weaker economy when those challenges hit,” Kronick said. “That might actually encourage more rate cutting to position the economy in a way to deal with those kinds of shocks.”

• Email: jgowling@postmedia.com

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