Another rate hold from the US Federal Reserve in May

Memo 1: US rates to stay "higher for longer": US Federal Reserve

The US Federal Reserve – the American central bank counterpart to the Bank of Canada (BoC) – held its trend-setting federal funds rate (FFR) unchanged in a range of 5.25 - 5.5% on May 1, citing stubborn inflation.

Like the BoC's Overnight Lending Rate, the FFR underpins variable borrowing costs offered by US lenders, and has been elevated since early 2022 in order to pull down the rate of inflation, which is currently 3.4%. However, this has proven tougher to do south of the border than in Canada, prompting the Fed to maintain a “higher for longer” rate stance, rather than preparing to cut borrowing costs as the BoC is currently doing.

In a press conference following the rate announcement, Fed Chair Jerome Powell made it clear that the inflation fight is taking longer than expected, and has increased faster than forecast in the first three months of the year. Improvements seen in inflation toward the end of 2023 had markets largely expecting the Fed would be in a position to cut rates by a total of 0.75% this year – but that progress has clearly stalled.

“​​Inflation has eased substantially over the past year while the labour market has remained strong and that’s very good news,” he stated. “But inflation is still too high, further progress in bringing it down is not assured, and the path forward is uncertain. We are fully committed to returning inflation to our 2% goal. Restoring price stability is essential to achieve a sustainably strong labor market that benefits all.”

However, Powell was careful to reiterate that the Fed isn’t planning a return to rate hikes, and that he believes existing policy is “restrictive” enough, which helped soothe market reaction to the rate hold. It’s now largely expected the Fed’s first downward move will come in December, assuming inflation starts to fall in line.

Memo 2: BoC continues their own “wait-and-see” stance on inflation

The growing divergence in the expected timing of rate cuts in the US and Canada was touched on in comments made by BoC Governor Tiff Macklem this week, in a question period with the House of Commons Standing Committee on Finance. 

After a May 2nd speech in which he reiterated that Canadian “monetary policy is working”, Macklem stated to the Senate committee that “The Canadian data and the American data are evolving in a slightly different way.” He added that this is a shift from six months ago, when the US inflation progress looked more promising than Canada’s. However, over the last three months, Canadian headline inflation has trended closer to the BoC’s 2% target, coming in at 2.9% in March.

However, the BoC’s main message continues to be one of ‘wait-and-see’; while markets are largely expecting a cut as early as June, Macklem has been careful to emphasize they need to see a solid downward trend in inflation before doing so.

“... as we consider how much longer to hold the policy rate at the current level, we’re looking for evidence that the recent further easing in underlying inflation will be sustained,” he said during his speech.

“Looking ahead, we expect core inflation to continue to ease gradually. The more timely three-month rates of core inflation are well below the 12-month rates, suggesting some downward momentum. But with gasoline prices rising, CPI inflation is likely to remain around 3% in the coming months. It is then expected to ease below 2½% in the second half of this year and reach the 2% target in 2025.”

However, he adds, risks around that forecast persist such as unexpected global tensions pushing up inflation, rising home prices, or stubborn wage growth.

The BoC’s next interest rate announcement will be on June 5, 2024.

Memo 3: Latest GDP report may confirm June rate cut

The latest numbers are in on the health of the Canadian economy, with all signs pointing to a considerable slowdown. The February Gross Domestic Product (GDP) report, released on Tuesday, April 30, by Statistics Canada, states the measure moved up 0.2% over the course of the month, following January’s 0.5% increase (revised from a previous 0.6%). This came in under expectation; economists had pegged the month’s performance at 0.3%, while StatCan itself expected 0.4% growth. From an annual perspective, GDP is up 0.8%, which is well below the called for 1.1%.

StatCan also released its “flash estimate” for March, saying it expects GDP will remain unchanged. Should that materialize, it would lead to a total of 2.5% growth in Q1 2024 – below the 2.8% the Bank of Canada forecast in its latest April Monetary Policy Outlook. 

Declines in the GDP per capita – the measure of the level of prosperity experienced by individuals – has also raised eyebrows. As reported by Gigi Suhanic in the Financial Post, several economists estimate it has cratered to recession-era levels, at around -1.2%.

That could well seal the deal for a rate cut come June, writes Randall Bartlett, Senior Director of Canadian Economics at Desjardins.

“For the Bank of Canada, today’s release kept the real GDP growth tracking for the first half of 2024 close to, and even slightly below, the outlook in the April 2024 MPR,” he states in an economic note. “The story so far this year has been similar for inflation. When combined with the ongoing deterioration in real GDP per capita and improving but still soft survey results, we remain of the view that the Bank is on track to begin cutting interest rates at its upcoming June meeting.”

Once the BoC starts cutting rates, variable mortgage rates will decrease in step, as well as fixed rates as the bond market reacts in kind. It will also lead to a decrease in the deposit rate for certain banking products, including GICs and high-interest savings accounts.

Also read:

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• How will the 2024 Federal Budget impact mortgage borrowers?
• Canadian CPI comes in at 2.9% in March
• Rising home prices made it more challenging to buy a home in March
• Federal government introduces 30-year amortizations for some insured borrowers