The Bank of Canada is likely to place more weight on the weakening state of the labor market in its coming rate decisions, opening the door to cuts early next year, according to economists at CIBC.
(Bloomberg) — The Bank of Canada is likely to place more weight on the weakening state of the labor market in its coming rate decisions, opening the door to cuts early next year, according to economists at CIBC.
Policymakers have hiked rates at 10 of their last 12 meetings, lifting Canada’s short-term borrowing costs to the highest level since 2001. But they’re probably done if the unemployment rate continues to move higher, Avery Shenfeld and Ali Jaffery of Canadian Imperial Bank of Commerce said in a report to investors.
Unemployment was 5.5% in July and economists surveyed by Bloomberg expect it to reach 6% in the fourth quarter. That’s above Canada’s non-accelerating inflation rate of unemployment — the lowest jobless rate that won’t cause inflation to speed up, the CIBC economists said. They estimate the Nairu, as it’s called, is 5.7%.
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“Labor market indicators, not the ever-vacillating measure of the output gap, will and ought to be the key” to the central bank’s direction, Shenfeld and Jaffery said in their report.
Excess demand in Canada’s economy is rapidly dissipating, the economists say. A drop in employment vacancies is one clear indicator of a softer outlook.
“If the Bank hikes in September, it would be doing so in the face of a job market outlook that suggests it’s not necessary,” Shenfeld and Jaffery wrote. Some economic models suggest rate cuts may come in the first few months of 2024, they added.
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“A couple more quarters of soft job gains and an upward creep in unemployment rate should do the trick,” they added.
Governor Tiff Macklem has been “gun shy” about saying employment is too high to achieve the 2% inflation target, the economists said — though they acknowledge it’s difficult for policymakers to state openly that more people have to lose their jobs for prices to stabilize.
Unlike some central banks, the Bank of Canada doesn’t provide official estimates of Nairu. Policymakers have focused instead on the output gap, the tough-to-measure difference between the actual and potential growth of a country’s economy.
Estimating the output gap has become more difficult because of the Covid pandemic, which produced supply and productivity shocks, the report says, noting that the Bank of Canada has revised potential growth rates multiple times.
The central bank’s next decision is Sept. 6. Economists expect Macklem will hold rates steady, though swaps markets have almost fully priced another 25 basis-point hike by the end of this year, with no rate cuts expected in the first half of 2024.
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