Excluding food and energy, prices rose 5.4% year-over-year (y/y) in September, following a gain of 5.3% in August. Prices for durable goods, such as furniture and passenger vehicles, grew faster in September compared with August. In September, the Mortgage Interest Cost Index continued to put upward pressure on the all-items CPI Canadians renewed or initiated mortgages at higher interest rates.

Monthly, the CPI rose 0.1% in September. On a seasonally adjusted monthly basis, the CPI was up 0.4%.
Average hourly wages rose 5.2% on a year-over-year basis in September, meaning that, on average, prices rose faster than wages. The gap in September was larger compared with August.

In September, prices for food purchased from stores (+11.4%) grew faster year-over-year since August 1981 (+11.9%). Prices for food purchased from stores have increased faster than the all-items CPI for ten consecutive months since December 2021.

Contributing to price increases for food and beverages were unfavourable weather, higher prices for essential inputs such as fertilizer and natural gas, and geopolitical instability stemming from Russia’s invasion of Ukraine.

Food price growth remained broad-based in September. On a year-over-year basis, Canadians paid more for meat (+7.6%), dairy products (+9.7%), bakery products (+14.8%), and fresh vegetables (+11.8%), among other food items.

Price pressures might have peaked, but today’s data release will not be welcome news for the Bank of Canada. There is no evidence that core inflation is moderating despite the housing and consumer spending slowdown. The average of the Bank’s favourite measure of core inflation remains stuck at 5.3%. Combined with the Governor’s recent harsh rhetoric, the high probability that the Fed will hike rates 75 bps at the next Federal Open Market Committee Meeting and the weak Canadian dollar, there is no doubt the Bank will increase their overnight policy target to at least 3.75%, and could well go the full 75 bps to 4.0% next week. I would bet that they will not quit there, with further hikes to come in December and next year by central banks worldwide.

The Government of Canada yield curve is now steeply inverted, reflecting the widely held expectation that the economy is slowing. The prime rate will increase sharply next week, increasing variable mortgage rates again. Fixed mortgage rates will rise as well, but not by as much, continuing a pattern we’ve seen since March when the Bank of Canada began the current tightening cycle. We are unlikely to see a pivot to lower rates in the next year as inflation pressures remain very sticky.

The full effects of the most recent rate hikes have not yet manifested. Statistics released today by the Canadian Real Estate Association (CREA) show that the slowdown that began in March in response to higher interest rates continued in September. Home sales recorded over Canadian MLS® Systems fell by 3.9% between August and September 2022. From May through August, month-over-month declines have been progressively smaller. The September result marked a slight increase in the current sales slowdown that began with the Bank of Canada’s first rate hike back in March.

While about 60% of all local markets saw sales fall from August to September, the national number was pulled lower by the fact markets with declines included Greater Vancouver, Calgary, the Greater Toronto Area (GTA) and Montreal.

The actual (not seasonally adjusted) number of transactions in September 2022 came in 32.2% below that same month last year. It stood about 12% below the pre-pandemic 10-year average for that month (see chart below).

“September was another month of lower sales activity, although, with many sellers also opting to play the waiting game, the market remains on the tighter side of balanced market territory,” said Jill Oudil, Chair of CREA. “It makes for an interesting dynamic, one that doesn’t really have many historical precedents. The market has changed so much in the last year, and the adjustment to higher borrowing costs is still underway.”

“Up until recently, higher borrowing costs had disproportionally affected the fixed-rate space, with buyers able to qualify more easily if they went with a variable rate mortgage,” said Shaun Cathcart, CREA’s Senior Economist. “The Bank of Canada’s most recent rate hike in early September finally closed that door, so it was not a big surprise to see additional softness on the sales side. The important thing to remember is we’re still in the middle of a period of rapid adjustment, with buyers and sellers trying to feel each other out while a lot of people have had to take their home search plans back to the drawing board. As such, resale markets may remain on the quiet side for some time yet, with the flipside of that coin being even more pressure on rental markets.”

Unusually, new listings would be so listless during a housing slowdown. However, the CREA data only go back 42 years, when interest rates trended sharply downward. Sellers today typically have mortgages at far lower than current rates, which no doubt dampens their enthusiasm to sell. Distressed sellers apparently listed their homes earlier this cycle, with the rest remaining on the sidelines for now. That could change if interest rates rise substantially further, although the incentives to stay in place continue high.

With sales down and new listings seeing a minor change in September, the sales-to-new listings ratio eased to 52% compared to 53.6% in August. The September 2022 reading for the national sales-to-new listings ratio was back on par with those in June and July and slightly below its long-term average of 55.1%.

There were 3.7 months of inventory on a national basis at the end of September 2022, up slightly from 3.5 months at the end of August. While the number of months of inventory is still well below the long-term average of about five months, it’s also up quite a bit from the all-time low of 1.7 months set at the beginning of 2022.

Breaking it down regionally, most of the monthly declines in recent months have been in markets across Ontario and, to a lesser extent, in British Columbia; however, in August, Ontario markets contributed most to the overall national decline.

Looking across the Prairies, prices in Alberta appear to have peaked. Prices still rise slightly in Saskatchewan, while Manitoba recorded the only decline. In Quebec, prices have dipped somewhat in the last couple of months. On the East coast, the softening of prices confined to Halifax-Dartmouth is now also appearing in New Brunswick, Newfoundland and Labrador. By contrast, prices in PEI continue to edge ahead on a month-over-month basis.

The non-seasonally adjusted Aggregate Composite MLS® HPI was still up by 7.1% on a year-over-year basis in August. This was the first single-digit increase in almost two years, as year-over-year comparisons have been winding down at a brisk pace from the near-30% record year-over-year gains logged just six months ago.
The Aggregate Composite MLS® HPI edged down 1.4% on a month-over-month basis in September 2022, not a small decline historically, but smaller than in June, July and August.

Breaking it down regionally, most of the recent monthly declines had been in markets across Ontario and, to a lesser extent, in B.C. The standout trend in August and September was that quite a few of those Ontario markets saw monthly price declines get stopped in their tracks, mainly in the Greater Golden Horseshoe. In a few markets prices even popped up a bit between August and September.

Looking across the Prairies, prices in Edmonton and Winnipeg are down a bit from their peaks, while prices are sliding sideways in Calgary, Regina, and Saskatoon. Similarly in Quebec, prices have dipped in Montreal but are mostly flat in Quebec City.

On the East Coast, price softness that had been confined to the Halifax-Dartmouth area appears to now be showing up in parts of New Brunswick and Newfoundland and Labrador, while prices in Prince Edward Island have flattened out in recent months but have not yet moved any lower.

The non-seasonally adjusted Aggregate Composite MLS® HPI was still up by 3.3% on a year-over-year basis in September, a far cry from the near-30% record year-over-year gains logged in early 2022.

In other news, US CPI data, released yesterday for September, show inflation remains stubbornly high, assuring another 75 bps increase in the US overnight policy rate when the Fed meets again on November 3.

A closely watched measure of US consumer prices rose by more than forecast to a 40-year high last month, pressuring the Federal Reserve to raise interest rates even more aggressively. The core consumer price index, which excludes food and energy, increased 6.6% from a year ago, the highest level since 1982. From a month earlier, the core CPI climbed 0.6%. On the heels of a solid jobs report last week and record-low unemployment, the inflation data likely cement an additional 75-basis point interest rate hike at the Fed’s November policy meeting. Even more noteworthy, however, is that immediately following the release of the inflation report, the market assessment of the maximum overnight rate rose from 4.6% to 4.85% for March of next year, substantially above the current overnight rate of 3.25%.

Bottom Line

The Bank of Canada’s next policy announcement date is October 26, when we will likely see another hike in the overnight policy target of at least 50 bps to 3.75%. Much will depend on next week’s release of the September CPI report for Canada on Wednesday, October 19. All eyes will be on the Bank’s measures of core inflation, which have been stubbornly sticky at above 5% on average. If the data disappoint on the high side, we can’t rule out a 75-bps rate hike the following week.

I believe both the Bank of Canada and the Fed will hike overnight rates further later this year and into next year. They are also not likely to begin to reverse these rate hikes until 2024.

You can see in the chart below that in late 1979, the Volcker Fed hiked the overnight policy rate to levels well above the inflation rate and kept real interest rates (nominal rate minus inflation rate) positive for an extended period.

The current Fed Chair, Jay Powell, has expressed deep admiration for Paul Volcker, calling him “the greatest economic public servant of the era.” Last month, Powell alluded to his predecessor’s record of persistence, saying that policymakers “will keep at it until the job is done” — invoking Volcker’s memoir, “Keeping at It.”

The Bank of Canada was no slouch on the inflation front as well. As the chart shows, the Bank hiked interest rates in lockstep with the Fed in the Volcker years and even more in the early 1990s when Ottawa was fighting Canadian budgetary red ink to the ground.

This time around, Tiff Macklem has been ahead of the Fed in hiking interest rates and, in a speech on Thursday, said that the economy is still “clearly” in excess demand, with businesses facing an extremely tight labour market, wage gains broadening and underlying inflation pressures showing no signs of letting up. Macklem said that the sources of inflation, which started with goods prices, are broadening to the service sector. “. Labour markets remain very tight. Job vacancies have eased a little in recent months but remain exceptionally high. Our business surveys report widespread labour shortages. And wage growth has risen and continues to broaden.”

“With demand running ahead of supply, competition is posing less of a restraint on price increases, and businesses are passing through higher input costs more quickly. As a result, higher energy and material costs are showing up in the prices of a growing list of goods and services. So even if there is some relief at the gas pumps, price pressures remain high and continue to broaden. In August, the prices of more than three-quarters of the goods and services that make up the CPI were rising faster than 3%.”

Macklem continued, “As we look for a more fundamental turning point in inflation, measures of core inflation are becoming increasingly relevant…after taking out volatile components in the CPI that don’t reflect generalized changes in prices, inflation is running about 5%. That’s too high. We can also see that our core measures have yet to decline meaningfully even though total CPI inflation has come down in the last couple of months. Going forward, we will be watching our measures of core inflation closely for clear evidence of a turning point in underlying inflation.” In conclusion, the governor said, “there is more to be done….We know we are still a long way from the 2% target. We know it will take some time to get there. We also know there could be setbacks along the way, and we can’t afford to let high inflation become entrenched.”

There are many views on how far the central banks will have to hike rates from here, but the critical issue is to reach a point where rates are meaningfully restrictive. A rule of thumb is that the overnight policy rate must rise to exceed the inflation rate. Fed Chairman Powell has said that he believes that real interest rates should be positive across the yield curve. Today, long and short US rates are still the lowest compared to inflation since the Burns era in the mid-1970s. (see chart below). Traders are betting that the US overnight rate will rise another 125 basis points (bps) by yearend and continue to rise next year to a median estimate of 4.6%.

Short-term money markets are betting the Bank of Canada will stop its hiking cycle at about 4%, versus a Fed benchmark rate peaking at about 4.6% and remaining below US short-term rates for at least another three years.

This is especially unreasonable given the fall in the Canadian dollar, which is now trading at US$0.728 compared to US$0.814 one year ago. This depreciation reflects the inordinate strength of the US dollar–the global safe-haven currency in a time of enormous uncertainty and volatility. The Canadian dollar has fared far better than other G-7 countries over this period. But the decline in our currency will raise the prices of the many US products and services we import, adding to inflation.

Inverted Yield Curves

In Canada and the US, 2-year yields have risen sharply to levels well above 5-year yields. As of October 6, the 2-year Government of Canada bond yield is at 4.0% compared to the 5-year yield at 3.49% and the 10-year yield at 3.31%. This implies the markets expect a slowdown in economic activity, but that does not mean that the overnight policy rate will fall in 2023 as Bay Street expects, especially if core inflation remains well above 2%. The Canadian prime rate is currently 5.45%, well above the 5-year yield of 3.49%. When the Bank of Canada Governing Council meets again on October 26, it will likely raise the policy rate by at least 50 bps to 3.75%, taking the prime rate up to 5.95% or higher—clearly improving the relative attractiveness of fixed-rate mortgage loans.

For most of my readers, inflation is a brand-new experience, and so are rising interest rates. Inflation in Canada was at 2.2% when the pandemic began, and the 5-year bond yield was a mere 1.3%. Quickly the central bank cut the overnight rate from 1.75% to 0.25%, the prime rate fell from 3.95% to 2.45%, and the 5-year bond yield fell to a low of about 0.32%. Housing demand exploded and continued strong until it peaked in February 2022 when the Bank of Canada began to hike interest rates.

Interest rates will not fall to pre-pandemic levels next year or even the year after. And we will likely never see interest rates at pandemic levels again, at least I hope not, because it would take another global economic shutdown. Hence, mortgage-borrower psychology will change. Many more homeowners will choose to lock in fixed interest rates, and by the time this is over, a new generation will realize that interest rates don’t just fall but sometimes rise to levels higher than expected and stay there longer than expected—a painful lesson to learn.

Canada added just over 21,000 jobs last month, with both full-time and part-time work increasing. Gains in educational services, health care, and social assistance were offset by losses in manufacturing; information, culture and recreation; transportation and warehousing, and public administration.

Employment increased in four provinces, led by British Columbia, while fewer people were working in Ontario and Prince Edward Island.

Total hours worked were down 0.6% in September 2022. Despite declining by 1.1% since June, total hours worked were up 2.4% y/y.

Bottom Line

Today’s labour force data in Canada and the US do nothing to deter the central banks from their rate-hiking paths. This is the last employment report before their decision dates–October 26th for the Bank of Canada and November 2nd for the Fed–although we will see the release of inflation and housing data before they meet again. It is already baked into the cake that rate hikes will continue.

Both central banks recently cautioned against market expectations that the fight against inflation was nearly over. Today’s data reinforce what we have already been told.