The Canadian jobs market is showing no signs of slowing. This has to make the Bank of Canada at least a bit nervous. The US jobs market data in January was also robust, and the Fed Chairman, Jay Powell, has assured markets that interest rates are likely to rise further.

This is the last jobs report before the Bank of Canada meets again on March 8. The CPI data for January will be released on February 21 and will be the primary factor determining Bank action. If inflation continues to decline, as expected, the rate pause will hold. If not…

The Bank will continue its policy of quantitative tightening, another restrictive measure. The Governing Council expects to hold the policy rate at 4.5% while it assesses the cumulative impact of the eight rate hikes in the past year. They then say, “Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.”

Bottom Line

The Bank of Canada was the first major central bank to tighten this cycle, and now it is the first to announce a pause and assert they expect inflation to fall to 3% by mid-year and 2% in 2024.

No rate hike is likely on March 8 or April 12. This may lead many to believe that rates have peaked so buyers might tiptoe back into the housing market. This is not what the Bank of Canada would like to see. Hence OSFI might tighten the regulatory screws a bit when the April 14 comment period is over.

Before today’s report, traders were pricing in a pause at the next policy decision, with a possibility of a 25 basis-point hike. Barring an excellent inflation report for December, another rate hike is likely on January 25, likely a 25 bp hike. Given what’s happened in the first three weeks of this month, there is a good chance that the almost 14% drop in gasoline prices (compared to a 4% decline in December a year ago) could pull this month’s headline inflation down to 6.5%. However, many components of core inflation continue to rise.

While the BoC will slow the rate hikes in 2023, at least two or three more hikes are still possible, with no rate cuts likely next year. Remember, wage inflation is running at 5.6% y/y, and wage negotiations are getting more aggressive.

Sellers remain on the sidelines as the number of newly listed homes edged down last month by 1.3%, declining 6.1% from a year ago. Most sellers are waiting for interest rates to fall, either because they expect a rebound in sellers or are unwilling to buy new properties themselves with mortgage rates so high.

While sales have swung wildly, new listing flows have remained relatively steady through the recent turbulence and are very much in line with pre-COVID norms. There’s still not a lot of forced selling, which can exacerbate a price correction.

New listings fell in slightly more than half of the local markets. Among the larger markets in Canada, month-over-month movements in new supply were generally small, the only exception being some more significant declines in the B.C. Lower Mainland and Okanagan regions.

In terms of monthly new supply, the bigger picture is listings are not flooding the market. With the one exception of 2019, November 2022 saw the fewest new listings for that month in 17 years.

With sales down month-over-month by a little more than new listings in November, the sales-to-new listings ratio fell to 49.9% compared to 50.9% in October. The ratio has remained close to around 50% since May. The long-term average for this measure is 55.1%.

Based on a comparison of the current sales-to-new listings ratio with long-term averages, about 70% of local markets are currently in balanced market territory.

There were 4.2 months of inventory on a national basis at the end of November 2022. This is close to where this measure was in the months leading up to the initial COVID-19 lockdowns and still nearly a full month below its long-term average.

The Aggregate Composite MLS® HPI now sits about 11.5% below its peak level. Breaking that down regionally, the general trend is prices are down somewhat more than they are nationally in Ontario and parts of B.C. and down by less elsewhere. While prices have softened to some degree almost everywhere, Calgary, Regina and Saskatoon stand out as markets where home prices are barely off their peaks at all.

OSFI announced this morning that the minimum qualifying rate for uninsured mortgages at federally regulated financial institutions would remain unchanged. They will review Guideline B-20 next month, but don’t hold your breath for an easing of the stress test.

In other news, housing starts were little changed last month at 264,600 annualized units. This is a strong level of new construction; the year-to-date average is roughly 265,000 units. Combined with the record 275,000 new units started last year, we are in line for the most significant two-year wave of housing starts on record. On a per-capita basis, we’re starting 2023 with an unprecedented construction boom despite higher costs, labour shortages and much higher interest rates.

Outlook   

The Bank of Canada is likely to raise the policy rate a couple of times by 25 bps in the first half of next year, pausing between rate hikes. They will not cut rates in 2023 even though the economy will post at least a mild contraction.

2024 will be a recovery year but don’t expect the overnight rate to return to the pre-Covid level of 1.75%. Indeed, the new cycle low will likely be more like 2.5% assuming inflation continues to trend downward. Price growth will be much more subdued than during the rocking ten-year period before the pandemic. Still, the underlying fundamentals of rapid population growth, mainly from immigration, bode well for sustained growth going forward.

Indicative of hiring strength, full-time employment was up a robust 50,700, and the private sector added 24,700 jobs. The jobless rate ticked down for the second consecutive month to 5.1%–well below the 5.7% rate posted immediately before the pandemic, which was considered full employment at that time. Total hours worked edged up, consistent with growth in the fourth quarter. And most notably, wage inflation came in at a year-over-year pace of 5.6% in November, the sixth consecutive month of greater than 5% wage inflation. Moreover, private and public sector unions demand even more significant wage gains as inflation remains close to 7%.

Businesses report difficulty filling jobs as job vacancies rose in the latest reading. The employment rate among core-aged women reached a new record high of 81.6% in November.
Employment rose in finance, insurance, real estate, rental and leasing, manufacturing, information, culture, and recreation. At the same time, it fell in several industries, including construction and wholesale and retail trade.

While employment increased in Quebec, it declined in five provinces, including Alberta and British Columbia.

Today’s data are the last key input into the Bank of Canada’s December 7 interest rate decision. Overnight swap markets are fully pricing in a 25 basis-point hike next week, with traders putting about a one-third chance on a 50 basis-point move. Rising wages show no sign of cooling, and the economy posted much more robust growth in the third quarter than the Bank expected.

The overnight policy rate target is currently at 3.75%. If I were on the Bank’s Governing Council, I would vote for a 50-bps rise to 4.25%. Returning to a more typical 25 bps rise is premature, given inflation is a long way above the Bank’s 2% target. Inflation will not slow, with consumers and businesses expecting continued high inflation. Wage-price spiralling is a real risk until inflationary psychology can be broken.

In either case, additional rate hikes early next year are likely. Even when the central bank pauses, it will not pivot to rate cuts for an extended period. Market-driven longer-term interest rates have fallen significantly as market participants expect a recession in 2023. Fixed mortgage rates have fallen as well. The inverted yield curve will remain through much of 2023, with a housing recovery in 2024.

Following four months of declines or little change, employment rose by 108,000 (+0.6%) in October. This increase—widespread across industries, including manufacturing, construction, and accommodation and food services—brought employment back to a level on par with the most recent peak observed in May 2022. All of the gain in October was in full-time work, another indicator of economic strength. This was the first gain among private sector employees since March when the Bank of Canada began hiking interest rates.

After declining in September, the unemployment rate remained at 5.2% in October, 0.3 percentage points above the record low of 4.9% observed in June and July. The adjusted unemployment rate—which includes people who wanted a job but did not look for one—was virtually unchanged in October at 7.1%.

In October, the labour force—or the total number of people who are either employed or unemployed—was 110,000 (+0.5%) more significant than in September. The labour force participation rate rose 0.2 percentage points to 64.9% in October but fell 0.5 percentage points short of the recent high of 65.4% in February and March 2022.

Employment rose by 24,000 (+1.4%) in manufacturing, mainly offsetting the decrease of 28,000 (-1.6%) recorded in September. Most of the increase was attributable to British Columbia (+12,000; +6.9%) and Nova Scotia (+3,700; +11.6%). On a year-over-year basis, employment in manufacturing was little changed.

The number of people working in accommodation and food services increased by 18,000 (+1.7%) in October, the first increase in the industry since May. According to the latest data from the Job Vacancy and Wage Survey, the industry had a higher job vacancy rate than all other industries in August.

Employment in professional, scientific and technical services rose by 18,000 in October (+1.0%), the third increase in six months. The number of people working in the industry has followed a long-term upward trend since June 2020, and in October was 297,000 (+19.3%) above its pre-pandemic level.

In October, the number of people working in wholesale and retail trade declined by 20,000 (-0.7%). Employment in the industry last increased in May and was little changed on a year-over-year basis in October. According to the latest data on retail trade, while retail sales increased 0.7% to $61.8 billion in August, advance estimates suggest that sales decreased 0.5% in September.

Of paramount importance to the Bank of Canada’s endeavours to wrestle inflation to a 2% pace, average hourly wages last month were 5.6% higher than one year earlier, accelerating from a rate of 5.2% in September. Despite average wages growing by more than 5% on a year-over-year basis in each of the past five months, they have not kept pace with inflation, which was 6.9% in September, contributing to concerns about affordability and the cost of living for many Canadians.

In separate news, the US employment data for October were also released today, showing stronger-than-expected hiring and wage gains, while the jobless rate ticked up a bit more than expected.

Bottom Line

Today’s labour force data in Canada throws into question the widespread assumption that the Bank of Canada can ease off the brakes very soon. I believe Governor Tiff Macklem will hike rates by another 50 bps in December and continue with 25 bp increases early next year. Today’s employment report raised the odds of the peak in the policy target of 4.5%.

Most market analysts had expected a 75 bps hike in response to the disappointing inflation data for September. Headline inflation has slowed from 8.1% to 6.9% over the past three months, primarily due to the fall in gasoline prices. However, the Bank said that “price pressures remain broadly based, with two-thirds of CPI components increasing more than 5% over the past year. The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing. Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched.”

In his press conference, Governor Tiff Macklem said that the Bank chose to reduce today’s rate hike from 75 bps last month (and 100 bps in July) to today’s 50 bps because “there is evidence that the economy is slowing.” When asked if this is a pivot from very big rate increases, Macklem said that further rate increases are coming, but how large they will be is data-dependent. Global factors will also influence future Bank of Canada actions.

“The Bank expects CPI inflation to ease as higher interest rates help rebalance demand and supply, price pressures from global supply disruptions fade, and the past effects of higher commodity prices dissipate. CPI inflation is projected to move down to about 3% by the end of 2023 and then return to the 2% target by the end of 2024.”

The press release concluded with the following statement: “Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Governing Council expects that the policy interest rate will need to rise further. Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. Quantitative tightening is complementing increases in the policy rate. We are resolute in our commitment to restore price stability for Canadians and will continue to take action as required to achieve the 2% inflation target.”

Reading the tea leaves here, the fact that the Bank of Canada referred to ‘increases’ in interest rates in the plural suggests it will not be just one more hike and done.

The Bank of Canada released its latest global and Canadian economies forecast in their October MPR. They have reduced their outlook across the board. Concerning the Canadian outlook, GDP growth in 2022 has been revised down by about ¼ of a percentage point to around 3¼%. It has been reduced by close to 1 percentage point in 2023 and almost ½ of a percentage point in 2024, to about 1% and 2%, respectively. These revisions leave the level of real GDP about 1½% lower by the end of 2024.

Consumer price index (CPI) inflation in 2022 and 2023 is anticipated to be lower than previously projected. The outlook for CPI inflation has been revised down by ¼ of a percentage point to just under 7% in 2022 and by ½ of a percentage point to about 4% in 2023. The outlook for inflation in 2024 is largely unchanged. The downward revisions are mainly due to lower gasoline prices and weaker demand. Easing global cost pressures, including lower-than-expected shipping costs, also contribute to reducing inflation in 2023. The weaker Canadian dollar partially offsets these cost pressures.

The Bank is expecting lower household spending growth. Consumer spending is expected to contract modestly in Q4 of this year and through the first half of next year. Higher interest rates weigh on household spending, with housing and big-ticket items most affected (Chart below). Decreasing house prices, financial wealth and consumer confidence also restrain household spending. Borrowing costs have risen sharply. The costs for those taking on a new mortgage are up markedly. Households renewing an existing mortgage are facing a larger increase than has been experienced during any tightening cycle over the past 30 years. For example, a homeowner who signed a five-year fixed-rate mortgage in October 2017 would now be faced with a mortgage rate of 1½ to 2 percentage points higher at renewal.

Higher borrowing costs are affecting spending on big-ticket items. Spending on automobiles, furniture and appliances is the most sensitive to interest rates and is already showing signs of slowing. As higher interest rates work their way through the economy, disposable income growth and the demand for services will also slow. Past experience suggests that the demand for travel, hotels, restaurant meals and communications services will be impacted the most. Household spending strengthens beginning in the second half of 2023 and extends through 2024. Population growth and rising disposable incomes support demand as the impact of the tightening in financial conditions wanes. For example, new residential construction is boosted by strong immigration in markets that are already particularly tight.

Governor Macklem and his officials raised the prospect of a technical recession. “A couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth” in the first half of next year, the bank said in the MPR.

The Bank of Canada’s surprising decision today to hike interest rates by 50 bps, 25 bps less than expected, reflected the Bank’s significant downgrade to the economic outlook. Weaker growth is expected to dampen inflation pressures sufficiently to warrant today’s smaller move.

A 50 bps rate hike is still an aggressive move, and the implications are considerable for the housing market. The prime rate will now quickly rise to 5.95%, increasing the variable mortgage interest rate another 50 bps, which will likely take the qualifying rate to roughly 7.5%.

Fixed mortgage rates, tied to the 5-year government of Canada bond yield, will be less affected. The 5-year bond yield declined sharply today–down nearly 25 bps to 3.42%–with the smaller-than-expected rate hike.

Barring substantial further weakening in the economy or a big move in inflation, I expect the Bank of Canada to raise rates again in December by 25 bps and then again once or twice in 2023. The terminal overnight target rate will likely be 4.5%, and the Bank will hold firm for the rest of the year. Of course, this is data-dependent, and the level of uncertainty is elevated.