December 22, 2023 Mortgage Memo: Sticky November inflation won’t derail rate cuts… Yet

Memo 1: November inflation was higher than expected… but no need for rate panic

The promise of impending rate cuts in the new year have greatly cheered markets in recent weeks, as central banks have taken a more dovish tone due to slowing economic data.

Investors’ celebrations may be preliminary, however, as latest CPI numbers offer up a reality check – Canada’s inflation fight isn’t over yet.

According to Statistics Canada, the headline inflation rate remained at 3.1% in November, unchanged from October’s reading, and edging up 0.1% on a monthly basis. This disappointed hopes the measure would finally dip below 3%, following months of stickiness. Inflation must reach a target of 2% before the Bank of Canada will consider loosening up monetary policy with rate cuts, and bringing forth long-awaited relief for variable borrowers.

The Core inflation measure – which is keenly watched by the Bank – was also stagnant, with both the trim and median prices remaining at 3.5% and 3.4%, respectively.

Rising mortgage interest continues to push the inflation dial higher, reports StatCan, up 29.8% on an annual basis; this, along with rising rents (+7.4%) and food purchased from stores (+4.7%) which were the “largest contributors to the year-over-year increase” in November. 

While grocery prices are starting to show some promise – down from their previous 5.4% – housing costs continue to be inflation’s biggest aggravator, writes Douglas Porter, Chief Economist and Managing Director of Economics at BMO.

“Shelter costs are a whole different ballgame, and remain the sore spot,” he stated in a note following the CPI announcement. “Mortgage interest costs did ease slightly on a yearly basis, but remain the number one contributor to headline inflation at up 29.8% y/y. Rent is relentless, and next in line at up 7.4% from year-ago levels. Other sources of upward pressure in the month included travel tours and women's clothing.”

But fears that a stickier CPI month could derail the BoC’s rate intentions are unfounded – for now. Porter points out that the measure has eased considerably from last year’s lofty 6.8%, and historic peak of 8.1% last June. Overall, the trend has been positive, he says, and also remains in line with progress made in the US.

“[The] moderately disappointing result drives home the point that we still have an inflation fight on our hands—in case there was really any doubt,” he writes.

“Still, the bigger picture remains intact: The underlying inflation trend is lower, the economy is chilly, and the Bank is expected to begin trimming rates around mid-year. As an aside, this result will not be a big shock to the Bank, as it had pencilled in an average inflation rate of 3.3% for Q4 in its latest forecasts (which now looks doable, with December likely to print higher). Still, the latest result reinforces the message that markets had been a bit aggressive in their pricing of early and often rate cuts.”

Memo 2: Summary of Deliberations

Speaking of the rate of inflation, the latest Summary of Deliberations released by the Bank of Canada on Wednesday further confirms the central bank was feeling good about CPI’s progress when it opted to marshal in a third-consecutive rate hold in its last announcement on December 6th.

According to the summary, which details the conversation and thought process among the Bank’s Governing Council, "Members agreed that the likelihood that monetary policy was sufficiently restrictive to achieve the inflation target had increased.” Translation: Enough rate hikes have been implemented to effectively reign inflation in, which the Bank has been striving to do since mid 2022.

“Governing Council members agreed that past increases in the policy interest rate were continuing to feed through the economy, slowing spending and relieving price pressures,” states the summary. 

While continuing to hedge against the possibility of future rate hikes with caution of future inflationary pressures and the need to “remain vigilant”, Council’s outlook calls for weaker consumption and business investment for the next two to three quarters. Core inflation – the headline number with volatile elements such as food and energy stripped out – is also trending downward over the long term.

“With the economy no longer in excess demand, members agreed they would be watching for signs that the slowdown in the economy was translating into further and sustained easing in inflation.”

Overall, pending any major economic surprises, the Bank’s language posits rate hikes are firmly in the rearview and that another hold is the most likely outcome of its upcoming announcement on January 24th, 2024. – a welcome turn of events for beleaguered mortgage borrowers.

Memo 3: BoC says it’s “too soon to consider” rate cuts

But that doesn’t mean the Bank’s top brass is in a rush to usher in an era of stimulative monetary policy. In his final remarks of the year, BoC Governor Tiff Macklem laid out some expectations for the new year – and warned that while inflation and the economy are trending in the right direction, it’s simply too soon to consider the timing of rate cuts. In a speech made on December 15 to the Canadian Club Toronto, he pointed to the victories achieved by the Bank’s rate cutting cycle, which just wrapped its second year: a no-longer-overheated economy, and cooling inflation.

While that’s “significant progress,” Macklem says, he understands that for many Canadians, the rate hiking measures taken to get here “doesn’t feel great.”

“We are in a tough phase of the monetary cycle. Inflation has come down but it’s still too high. And the increases in interest rates that are needed to relieve price pressures are squeezing many Canadians,” he stated.

Looking ahead, 2024 is expected to be a key transition year, as the effects of previous hikes continue to work through the economy, leading to a necessary period of economic weakness before achieving balance. Macklem says the Bank expects inflation to reach its 2% target later next year – but when it comes to officially wrapping up the hiking cycle, it’s just too soon to celebrate.

“[Once] Governing Council is assured that we are clearly on a path back to price stability, we will be considering whether and when we can lower our policy interest rate,” he stated.

“I know it is tempting to rush ahead to that discussion. But it’s still too early to consider cutting our policy rate. Until we see evidence that we are clearly on a path back to 2% inflation, I expect Governing Council will continue to debate whether monetary policy is restrictive enough and how long it needs to remain restrictive to restore price stability. In a world with increased macroeconomic volatility, we are also conscious that we may need to be nimble, and we should be humble about our forecasts.”

Analysts are increasingly expecting rate cuts to come as soon as April, as indicated by overnight swap activity, with 50 - 100 basis points to be shaven off the cost of borrowing by the latter half of the year. In a series of 2024 mortgage predictions released by Ratehub.ca, Co-CEO and President of CanWise mortgage lender James Laird says, “The Bank will hold the target for the overnight rate at 5% for the first half of 2024 and will start making cuts in the second half of the year.”

Also read:

• Ratehub.ca’s 2024 mortgage predictions
• US Federal Reserve signals rate cuts in 2024
• Home affordability improved across most of Canada in November
• Bank of Canada holds its target interest rate at 5% in December announcement