As major North American equity indexes flirt with record highs, investors shift their focus to economic data and central bank announcements to gauge market direction. Notably, CIBC’s deputy chief economist, Benjamin Tal, stood out earlier this year by accurately predicting that the Bank of Canada (BoC) would not cut rates in the spring. Now, as inflation trends and economic growth continue to evolve, Tal provides updated insights into what lies ahead for Canada’s economy and stock market.
Is Inflation Cooling Enough for a Rate Cut?
Tal emphasizes the complexity of measuring inflation, highlighting various metrics such as CPI, core CPI, and CPIX, each with its nuances. He argues that the narrative often shapes the data interpretation rather than the data dictating the narrative. Despite diverse inflation metrics, Tal believes the trend indicates sufficiently low inflation to justify a rate cut in June. Excluding mortgage interest payments, core inflation is already below target. He suggests that if the BoC operated purely on data, it would have stopped raising rates sooner.
The Gap Between the Fed and BoC
Currently, the BoC’s policy rate is 25 basis points lower than the Federal Reserve’s. Typically, this gap ranges from 75 to 100 basis points due to the more responsive Canadian monetary policy. Tal argues that the BoC may be overshooting with its current rates, as the Canadian mortgage structure and leverage levels mean that the same economic impact can be achieved with lower rate hikes compared to the U.S.
Economic Growth and Recession Risks
Tal notes that while Canada’s GDP growth in the first quarter was stronger than expected, this was driven more by supply chain improvements than demand. He foresees near-zero GDP growth in the second half of the year, pointing to a recession in per capita terms, with GDP growth rates reminiscent of the 1991 and 2008 recessions. For the U.S., Tal sees signs of economic slowing, which is necessary for the Fed to combat inflation successfully.
The Housing Market Outlook
Regarding the housing market, Tal highlights significant price increases in detached homes and condos since pre-COVID times. He predicts that while the worst may be over for detached homes, the condo market remains weak due to a lack of presales and new construction. However, he expects a rebound in prices in the long term as interest rates fall and demand persists.
RBC’s Carrie Freestone Predicts Aggressive BoC Rate Cuts
In contrast, RBC economist Carrie Freestone forecasts a more aggressive rate-cutting path for the BoC compared to the U.S. Federal Reserve. By the third quarter of 2025, Freestone anticipates the BoC will have cut its key lending rate by two percentage points, while the Fed will have eased by only 75 basis points.
Diverging Paths of the BoC and the Fed
Freestone predicts the BoC will initiate a 25-basis point cut in June, followed by additional cuts totaling 100 basis points this year and another 100 next year. This outlook diverges significantly from the Fed’s expected path, where only 75 basis points of cuts are anticipated through 2025. The differing economic conditions in Canada and the U.S. underpin this divergence, with Canadian inflation data showing more substantial improvement.
Impact on the Canadian Dollar and Inflation
Freestone acknowledges that the divergent rate paths will likely weaken the Canadian dollar, forecasting it to drop to 75 U.S. cents by the end of 2025. Despite potential inflationary pressures from higher import costs, she believes this will not significantly fuel overall inflation in Canada, given that more than half of consumer spending is on services and only 35% of consumer goods imports come from the U.S.
Economic and Housing Market Projections
Freestone’s baseline outlook for Canada’s economy includes modest GDP growth and a gradual improvement in consumer spending. She predicts an increase in resale activity in the housing market once the BoC starts cutting rates, with home prices expected to rebound after a period of weakness. However, affordability challenges will persist, particularly in major urban centers.
Addressing Productivity and Immigration Challenges
Freestone expresses concern over Canada’s lagging productivity compared to the U.S. and emphasizes the need for better integration of immigrants into the labor market. With an aging population and growing healthcare costs, she argues that effective immigration policies are crucial for maintaining economic stability and addressing labor shortages.
Links:
https://www.theglobeandmail.com/investing/markets/inside-the-market/article-cibcs-benjamin-tal-was-one-of-the-few-to-correctly-predict-the-bocs/
https://www.theglobeandmail.com/investing/markets/inside-the-market/article-rbc-economist-predicts-two-percentage-points-of-boc-rate-cuts-within-a/