C.D. Howe urges rate hold at 2.25%

Key Concepts

• Overnight Rate: The target rate for major Canadian financial institutions to lend each other money overnight, set by the Bank of Canada.
• Inflation Target: The Bank of Canada’s goal of keeping inflation at 2%.
• Core Inflation Measures: Measures of inflation that exclude volatile components like food and energy prices, used to assess underlying inflationary pressures.
• Monetary Policy Council: The governing council of the Bank of Canada responsible for setting monetary policy.
• Koosma Negotiations: Refers to the renegotiation of the Canada-United States-Mexico Agreement (CUSMA), formerly NAFTA.
• Fiscal Policy: Government spending and taxation policies.
• Yield Curve: The relationship between interest rates (or "yields") and different maturities for debt securities.

Canadian Economic Outlook: CD Howe Institute’s Perspective

Maintaining the Overnight Rate: The CD Howe Institute’s Recommendation

The CD Howe Institute is advocating for the Bank of Canada to maintain its current overnight rate at 2.4%. This recommendation stems from a strong consensus within the Institute that Canadian inflation is trending towards the 2% target. Despite significant economic and political volatility, the Institute believes the current economic softening is aligning with the Bank of Canada’s objectives for achieving its inflation goal. Bill Robson, President and CEO of the CD Howe Institute, emphasized this point, stating the group was “very much of one mind” on maintaining the rate “at least in the near term.”

Potential Risks of Rate Adjustments

While the preferred stance is to hold steady, the Institute considered the implications of both rate cuts and increases. A rate cut was met with limited enthusiasm, with only one member recommending a cut over the coming year. The primary concern was that inflation remains above target, and core inflation measures continue to demonstrate strength. Robson noted caution regarding the possibility that “inflation might not actually be licked.” Conversely, a rate increase was also deemed undesirable due to the potential to stifle economic growth.

Current State of the Canadian Economy: Delicate and Fragile

The Canadian economy is described as “delicate” and “fragile,” with consumers appearing “pretty tapped out.” While recent monthly retail numbers showed a strong increase, this followed a period of weak performance. StatsCan data reveals that real retail sales have remained stagnant recently. Furthermore, the Bank of Canada’s consumer confidence survey indicates that Canadians are feeling financially “pinched” and concerned about the weakening labor market. A significant factor contributing to this outlook is the upcoming wave of mortgage rate resets, which will further strain household finances and limit consumer spending. Robson predicts consumer spending will not be a significant driver of economic growth in 2025 or 2026.

Potential Economic Drivers & Challenges

With consumer spending expected to remain subdued, the Institute is looking to other potential drivers of economic growth. Equity markets are showing some strength, presenting a potential positive. However, significant uncertainty surrounds the ongoing Koosma negotiations with the United States, with Donald Trump introducing unpredictable elements. A successful negotiation preserving existing market access, coupled with strength in the materials sector, could lead to relatively positive economic performance. However, Robson cautioned that the much-touted federal government investment projects are currently lacking concrete action, consisting primarily of “noise” and “large numbers in terms of dollar signs” without immediate impact.

Impact of US Monetary Policy & Fiscal Situation

The potential for interest rate cuts by the US Federal Reserve does not pose a direct threat to the Bank of Canada’s independence. However, Robson highlighted potential challenges. If US long-term interest rates rise, it will exert upward pressure on global rates, potentially forcing the Bank of Canada to raise its overnight rate to maintain control. A widening gap between Canadian short-term rates and US long-term yields could also “accelerate monetary policy.” Furthermore, higher inflation in the US could strengthen the Canadian dollar, which some may find undesirable.

Recent weakening of the US dollar is attributed to a general “US off mood” in markets, largely driven by the unpredictable nature of Donald Trump’s policy announcements. Robson expressed a belief that the Fed will likely navigate these challenges without significant disruption, but acknowledged the inherent risks associated with the US’s “hyperextended” fiscal policy, suggesting that some form of correction is inevitable, potentially leading to inflationary pressures.

Notable Quotes

• “The path of inflation in Canada is toward 2%.” – Bill Robson, summarizing the CD Howe Institute’s core assessment.
• “Consumers are looking pretty tapped out.” – Bill Robson, describing the current state of Canadian consumer finances.
• “Nobody’s counting on [federal investment projects] in the near term. We’re hearing a lot of noise and we’re seeing a lot of large numbers in terms of dollar signs.” – Bill Robson, expressing skepticism about the immediate impact of government spending plans.

Data & Statistics Mentioned

• Overnight Rate: Currently at 2.4%.
• Inflation Target: 2%.
• Retail Sales: Real retail sales are stagnant according to StatsCan data.
• Bank of Canada Consumer Confidence Survey: Indicates consumers are feeling financially strained.

Synthesis & Conclusion

The CD Howe Institute advocates for a cautious approach to monetary policy, recommending the Bank of Canada maintain its current overnight rate. This decision is based on the belief that inflation is trending towards the 2% target, despite ongoing economic and political uncertainties. The Canadian economy is currently fragile, with consumers facing financial pressures and limited potential for significant growth. While potential drivers like equity markets and successful trade negotiations exist, significant risks remain, particularly related to US economic and political developments. The Institute emphasizes the need for careful navigation of these challenges to maintain economic stability and achieve the Bank of Canada’s inflation target.