Residential Mortgage Commentary - Inflation & Interest Rates: Lead Characters for 2023

A lot of the recent talk in financial and real estate circles has been centering on the possibility of a pause in the Bank of Canada’s aggressive interest rate increases. Some speculate that could happen at the next rate setting, later this month.

The Bank raised rates seven times last year in an effort to rein-in galloping inflation. It does seem to be working, but there are some stubborn sticking points.

Headline inflation, known as the Consumer Price Index (CPI), has dropped. It was 8.1% in July and drifted down to 6.8% in November. However, the drop from October to November was a mere one-tenth of one percentage point and the Bank’s target rate remains significantly below that, at 2.0%.

As well, the BoC’s preferred inflation measure, Core Inflation (which strips out volatile components like food and fuel), actually increased. A simple averaging of the three components that the Bank uses to measure Core Inflation came in at nearly 5.7% in November, up from 5.3% in October.

Other factors that figure into the Bank’s plans include Gross Domestic Product and unemployment. Canada’s GDP continues to grow, albeit modestly, despite rising interest rates. It increased by 0.1%, month-over-month in November. Unemployment dipped 0.1% to 5.0% in December. Both of these tend to fuel higher wages which are a key driver of inflation.

The Bank of Canada, itself, remains firmly dedicated to battling back inflation. Governor Tiff Macklem has said he would rather over-tighten than under-tighten and run the risk of having high inflation linger and become entrenched.

The U.S. central bank has made it clear it plans more rate hikes. Given the integration of the Canadian and American economies, the Bank of Canada does have to pay attention to what its American counterpart does.

The BoC will have new economic data by the time it makes its January 25th announcement. The December numbers will provide a fresh look at how well the inflation fight is going.

Normally it takes 18 to 24 months for interest rate increases to work their way into the economy and we are only about 10 months into this tightening cycle. It is reasonable to expect another 25 basis-point increase on the 25th. Given the Bank’s apparent success so far it also seems reasonable to expect a pause sometime after that.

Looking ahead to a year from now some forecasters say we might start to hear talk of interest rate cuts, which would be welcome news. Cuts would allow the BoC to move toward its, long stated, goal of normalizing rates back into the neutral range of 2.5% to 3.5%. The Bank of Canada, and central banks around the world, have been trying to do that for more than a decade – since the ’08 - ’09 financial collapse.