RBC GAM chief economist outlines why he thinks Tiff Macklem is under less pressure to cut now than many predicted
A few months ago, analysts predicted that the Bank of Canada’s April interest rate announcement would be the first ‘live’ decision of 2024. This is the first announcement of the year where a possibility of interest rate cuts has been priced in by the market, and investors are somewhat less confident of exactly what BoC Governor Tiff Macklem will do or say. Eric Lascelles, however, prefers to take a page from The Princess Bride and think of this ‘live’ decision as “mostly dead.”
The chief economist at RBC Global Asset Management (GAM) says that the economic picture in Canada appears to be improving somewhat, which should give Macklem cover to hold interest rates steady at 5 per cent tomorrow. Lascelles believes that it’s the June and July announcements where investors can most likely expect a cut and is more confident in July as a date for the first cut. The tone Macklem takes in this announcement and the focus of the monetary policy report that will be released following the announcement will help inform that view going forward.
“Ultimately this does come down to how the economy is doing and how inflation is doing, and the economy has held up quite nicely over the last quarter,” Lascelles says. “The Bank of Canada starts with the international picture, and we are seeing good growth across a wide range of countries, and even a bit of acceleration in the US and Europe. Domestically you can always poke holes, retail sales weren’t to special trade wasn’t so great, but in general the economic data in Canada has looked quite good since the last Bank of Canada decision.”
Lascelles cites slight upticks or at least steady maintenance of employment in recent months, along with wage growth at around 5 per cent per year, which is significant when you consider that productivity is falling. The Bank of Canada’s own business outlook survey also showed a more optimistic outlook from businesses than we have seen in recent months. This is not an environment, he says, that demands a cut in interest rates which could prompt a spike in inflation.
Another area that Macklem and the Bank of Canada have to be very circumspect about is the housing market. Compared with the US Federal Reserve, the BoC has not offered much forward guidance on rate cuts or delivered the same dovish tone in its statements. Lascelles says that Macklem seems concerned that any interest rate cut — however symbolic — could signal a rush in the Canadian housing market that will further negatively impact the ongoing affordability crisis.
Inflation will also sit at the core of the BoC’s decision, Lascelles says. While CPI has come down in recent months, it’s still sitting above the BoC’s target 2 per cent rate. Oil prices have also moved up significantly this month, which will have an inflationary impact. While the BoC prefers to look at so-called ‘core inflation,’ which excludes food and energy prices, if energy costs cause a significant spike in headline CPI that could still impact Macklem’s decision around cuts going forward.
“I pay a lot of heed to the risks that the Bank of Canada explicitly identifies in its monetary policy reports,” Lascelles says. “The main downside risk — the argument for cutting more or sooner — is an economic slowdown, which isn’t manifesting…The upside risk is that inflation doesn’t settle.”
Lascelles doesn’t expect that the monetary report will pull in many new factors in April. The same issues around productivity, GDP growth, and inflation will likely sit at the core of what the BoC talks about. One issue that Lascelles thinks Macklem will be considering, if not explicitly mentioning, is the looming Federal budget announcement on April 16th. With new pharmacare commitments, debt servicing costs, and national defence conservative estimates project a deficit twice as large as last year’s.
While not exclusive to Canada, Lascelles notes that governments’ willingness to spend freely has been a growth driver for many developed economies. He argues that the US has been far more willing to use spending to spur growth. Nevertheless, Canadian spending has also been net stimulative, which is an inflationary and does impact the outlook for interest rate cuts slightly.
Given the role of expectations and the BoC’s caution about spurring undue froth in the housing market, Lascelles argues that we won’t see clear signals of a cut telegraphed before it comes. When those cuts do come, the tone and nature of them may be somewhat different from what many investors had expected at the start of the year.
“Historically, central banks take the elevator down when they cut rates. It’s usually quite a rushed, urgent affair. This could be a more leisurely period of rate cuts,” Lascelles says. “It doesn't seem to be one that would be motivated by a recession, so it can be slower moving, I think there's a lot of uncertainty as to what constitutes a neutral interest rate, so there will be some tentative steps and some pauses to see just how the economy responds. It's unlikely to be a rapid journey. But nevertheless, we are perhaps about to slowly begin a path back to more normal interest rates.”
