New economic changes are on the horizon with fluctuating interest rates, living costs, and changing inflation. Get a look into the future of the Canadian economy.
Whether you're looking for a new mortgage, contemplating your investment strategy, or simply trying to make sense of the economy, join us for a conversation with Avery Shenfeld, Managing Director and Chief Economist at CIBC Capital Markets, to shed light on the recent interest rate cut, its expected impact on the Canadian economy, and what this means for consumers.
Here are three reasons why you should listen to this episode:
[03:24] Avery: "It's not the first move that will matter, but it's really the follow-up from the Bank of Canada. We've got to get that short-term interest rate down to something like three percent or two and three-quarters."
Historically, Canada and the US differ in economic performance and interest rates. These reflect the differing needs of the two economies and the varying interest rates.
[10:34] Avery: "The overall temperature of the global economy is not likely to be that vigorous in the balance of this year, where our hopes lie is really for 2025, after a sequence of interest rate cuts, not just in Canada, but in Europe, and eventually in the US as well."
Global growth and domestic demand improvement due to interest rate cuts can lead to a better year for the Canadian economy by 2025.
[19:31] Avery: "Canada's economic performance, it really hasn't been great, particularly on a per capita basis. And I think we need to see an improvement in output per hour or productivity that we have been seriously lacking over the last year or two."
Avery Shenfeld is the Managing Director and Chief Economist at CIBC Capital Markets. With a distinguished career spanning over two decades, Avery is a highly respected figure in the field of economics. He regularly provides expert analysis on economic changes, trends, and policies, offering valuable insights to both the media and CIBC clients.
Avery's expertise covers a wide range of economic issues, including monetary policy, inflation, and market dynamics. He is a trusted voice in understanding and navigating the complexities of the Canadian economy.
Learn more about Avery and his work on the CIBC website.
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Carissa: Welcome to Smart Advice, a podcast connecting you with real financial advice, investment strategies and economic trends, empowering you with insights you need to make smart decisions about your money. I'm CIBC financial advice expert Carissa Lucreziano.
Today we're going to talk about the Canadian economy from the perspective of what Canadians really want to know and should be thinking about when it comes to their finances. I think inflation is going to be one of those words most people would want on the bench list for 2024. After two years and ten interest rate hikes later, one of the most aggressive monetary policy tightening campaigns on record, we finally had the first rate cut on June 5th by the Bank of Canada. Canadians are looking to the rest of 2024, hoping for a bit more reprieve where they are not feeling so squeezed by interest rate pressure and settled into a more contained and stable economic environment.
According to the June CIBC consumer sentiment tracker, Canadians remain concerned about two very important issues: the overall economy and the cost of living, and rightly so. However, a silver lining is emerging with more Canadians confident their situation will improve in the next year. There are a lot of moving parts to the Canadian economy, impacting how we make big and small financial decisions around spending, saving and investing.
A slowing inflation rate, excess supply and weaker than expected economic growth. This is good news towards more rate cuts that may be on the way later this year. We will talk about this and more today.
I want to welcome Avery Shenfeld, Managing Director and Chief Economist at CIBC Capital Markets. Avery is one of Canada's leading economists and regularly lends his expertise to the media with timely and essential perspectives. He is here to give our listeners a view of what will continue to unfold and what to expect over the coming months.
Thanks for joining us today. Avery.
Avery: It's my pleasure.
Carissa: Last time you and I chatted in 2023, the Bank of Canada had decided to hold rates steady after wrapping them up to 5%. Inflation was sitting at 3.3. And you said that we would probably go through more economic pain to see inflation continue to decrease. Well, you were right. On June 5, the Bank of Canada took the 5% policy rate down 25 basis points to 4.75%. Will this rate decrease make an impact?
Avery: Well, I suppose in terms of the impact to take a paraphrase of a song title, the first cut isn't the deepest, at least when you're thinking about: is this really going to help the economy? A mere quarter point reduction from an interest rate of 5% isn't going to mean much to most Canadians when they're thinking about borrowing to buy a house, a car and so on. And the reality is that interest rates are still quite elevated.
Many Canadians are still renewing mortgages at rates that are quite a bit higher than the mortgages they're replacing. So, it's not the first move that will matter. But it's really the follow up from the Bank of Canada. And we're really talking about over the next year and a half through 2025.
We've got to get that short-term interest rate down to something like 3% or 2.75. That's a level that will be less punitive for the economy and the path getting there is going to help in terms of economic wealth, but it's not something we're going to see right away.
Carissa: Good insight. Canada is the first G7 country to have cut their interest rates. And the European Central Bank followed suit with its first rate cut in five years. The US Federal Reserve is perceived, as you know, to hold its rate until at least September.
Avery, we've heard that too much divergence from the US in the way of rate cuts could impact our dollar and other negative effects on our economy. Can you unpack this divergence? And how does the Bank of Canada manage this balancing act?
Avery: If we look back historically, you can see that Canada does have a made-in-Canada interest rate policy. Of course, it's true that economic booms and recessions tend to coincide between Canada and the US, so the biggest interest rate cuts are often taking place at times both countries are in recession. And interest rate hikes tend to happen when inflation or growth has escalated in both countries.
But there have been divergences sometimes as far as some full two percentage points in terms of the overnight rate of interest. Typically, more likely, you see divergences of around a full percentage point. And they really reflect differences in the need for either high or low interest rates in the two economies.
So, if we look back over the past year and a half or so, the Canadian economy has seriously underperformed the US economy in terms of growth. The Canadian economy has generally seen a bit more of an easing and inflation pressures than the US as a result. So, we clearly are in a greater need of some interest rate relief than our neighbors to the south.
It does make sense therefore, that the Bank of Canada started to cut somewhat before the Federal Reserve has done. And a differential as wide as a full percentage point really would not be problematic. You might get a little bit of a weakening in the Canadian dollar as a result of that. But the pass through of a couple of cents’ weakness in the Canadian dollar, in terms of what that means for inflation in Canada isn't really that material.
Importers can put different prices to different countries; they do that all the time. And, of course, when we look at the overall Consumer Price Index, two thirds of that is services that aren't really subject to trade, and therefore don't really respond much to currency moves.
So the Bank of Canada pretty much has a free hand. If it needs to, and wants to, it could cut another couple of quarter point cuts, for example before the Fed has moved. And that wouldn't be out of line with either historical performance or what the Canadian economy really needs.
Carissa: Well, it's good to know that the Bank of Canada has that flexibility, and on the topic of the Consumer Price Index: inflation has crept into our lives and everything from our grocery bill to rent, mortgage interest payments, and even a meal at our favorite restaurant is so much more expensive.
The Consumer Price Index, or CPI as you would see it mostly referenced, measures inflation by tracking the changes in prices paid by consumers for a basket of goods and services over time. Avery, what specific items in this basket of goods and services, we've heard so many references like food and shelter, will impact the most towards that 2% target the Bank of Canada wants to see?
Avery: If we look back since the peak of inflation that we had last year, the biggest improvement has come on the good side of the economy. And that's what we expected because a lot of the goods inflation we were seeing, everything from cars to furniture, appliances, was related to global production issues that go way back to the pandemic. So China's shutting down factories for the better part of a year, disruptions in fact we saw elsewhere, were due to COVID, shipping issues and so on. And as goods became more available, we started to see price increases that were much more muted.
So you can find a car on a dealer lot, you might actually get a sale on that car, that contrasts to when all these goods were in short supply, where no one was giving you a discount off the list price. So we've seen a lot of progress there. If we look at the road ahead, and what is going to take us to 2%, it really is in the shelter component.
And there's two big items there, one of which is rent inflation, which was escalated in part because of rapid population growth last year. And we do expect that by 2025, revise government policies on students and non-permanent residents who are allowed to come into work to Canada, we're going to see much smaller numbers of those two sources of emigration, which should help ease rent inflation a bit, at least in 2025.
But the other key item is actually mortgage interest costs. So perversely, when the Bank of Canada raises interest rates to slow the economy and contain inflation, there's one part of the inflation measure that they push up. And that's the measure of what it's costing you for your mortgage payments.
So as Canadians have been renewing mortgages, at higher interest rates, that component of inflation is running at over 20% year on year inflation. And it's the one item then when the Bank of Canada cuts interest rates, that they can start to actually use those rate cuts to reduce that part of inflation.
So I think from where we are now, to get back to 2%, the progress is largely going to be in that mortgage interest component coming down over the next year and a half, because by the end of 2025, people, particularly with variable rate mortgages or short term mortgages, one year or two year mortgages that are renewed deeper into 2025 are going to see some substantial savings that will show up in that part of the inflation basket.
Carissa: Yeah, and you know, at a 30% weighting, I think it's a big impact to CPI. So that's good news because to your point, the more Bank of Canada raises the interest rates, the more pressure it is on mortgage interest. So with one rate cut under the belt, and possibly more on the horizon — we're all hoping — how is the second half of the year shaping up for the Canadian economy?
Avery: It’s still going to be a bit sluggish. Maybe by the end of the year, the housing turnover will be revived a little bit by people getting out and listing homes and buying homes in a way that we haven't seen.
But we're also expecting the US economy to slow a little bit as we move further into the year. US consumer spending is showing some signs of easing off. So, it's not a dramatic slowdown, but the overall temperature of the global economy is not likely to be that vigorous in the balance of this year, where our hopes lie is really for 2025, after a sequence of interest rate cuts, not just in Canada, but in Europe, and eventually in the US as well.
We do expect global growth to be improving, we expect Canada to get some benefit from that. But also some domestic demand improvements in the face of lower interest rates should help as well. So our fingers are crossed that 2025 will finally be a better year for the Canadian economy. And in the near term, I would expect growth to still be barely sluggish, not no disaster, not a recession, but a little bit disappointing, certainly over the balance of this year.
Carissa: Now let's talk about the Canadian consumer, because that's a very important factor. And it has been over the last several years to this whole story. There has been more of a regimented focus on managing household budgets and putting extra cash flow to savings. Like you mentioned, rising mortgage costs will remain a burden on household finances, even if it is in the shorter term.
Where are Canadians cutting back? And will there be a resurgence of spending as rates decline?
Avery: So we've certainly seen that and what you see is if you look at the difference between Canada and the US and Americans benefit from the fact that their mortgages are locked in for 30 years, so they don't have to renew them as rates rise. And what we've seen is a dramatic difference in spending and savings behavior across the two countries.
So Canadians have been saving an increasing portion of their after tax income. And I think that just reflects people getting ahead of mortgage renewals that are going to cost them more, and therefore being a little cautious on spending. Americans have actually been generally saving less and less of their money and spending more of that. So there's been big differences, you know, goods consumption, for example, has been much more vigorous in the US than it has been in Canada. But even in some services, we haven't fully restored our free spending ways that we had prior to the pandemic.
So this was sensible responses by Canadians to the drag from higher interest rates. It is really what the Bank of Canada was counting on when it raised interest rates that actually wanted to slow economic wealth, wanting people to save more of their money, getting the reward from higher interest rates, and borrow less in order to save on interest costs. All of that has slowed consumer spending growth in Canada, it still has been growing.
But if we looked at on a per capita basis, remembering that we had massive population growth last year, it's been quite weak. It's in fact been in many cases, we've seen quarterly declines on a per capita basis in household spending.
So it's been a predictable response to higher interest rates. It's going to be part of the story of how the Canadian economy gathers speed in 2025 — that in the face of lower interest rates, we would expect more people to go out and borrow to buy a car, for example, or take a vacation. We're going to give some relief to people with variable rate mortgages that will give them a little bit more elbow room for spending.
Carissa: Any sector or specific goods or services do you think will be impacted the most, or as an outlier?
Avery: I think the biggest, you know, the biggest change will be in areas tied to housing turnover. So you hear in a given quarter, people say, “Oh the real estate market picked up this quarter.” But generally speaking, that volume of sales has been quite low. That's particularly true in for example, new condos. There are a lot of condo projects that have been launched and people aren't really buying them. Interest rates are too high to make a good return for investors, for example, to buy them and rent to somebody else.
So where we expect to see an improvement is in fact on some of those interest sensitive areas of demand aware when we get into 2025 I think you'll see more housing turnover. That brings with it some other spending. So furniture for example, people tend to buy new furniture when they move into a different home, appliances and so on. So it's really the whole complex of things tied to housing that could see some improvement when we get into what 2025
Carissa: Definitely. Okay, let's shift to the stock market and Canadian bonds and stocks rallied after the Bank of Canada announced this rate cut on June 5, many Canadians wanting to continue to invest, some still sitting on the sidelines. How do financial markets respond in the second half of 2024?
Avery: So we've had a pretty good run for equities, more so in the US than Canada. And I'm a bit concerned that maybe equities are now pretty fully valued for these interest rate cuts to come. And so they benefited from expectations of that, not sure that there's that much juice there left between here and the end of the year. So, a bit cautious there.
But see some offsets now with some room in the bond market for bond yields to come down and therefore returns on fixed-income investments to do a little better. And we're now in a period, I think, where we're going to get the usual backstop between these two asset classes. So that wasn't the case, for example, in 2023, and earlier in the cycle, we had some periods where the equity market wasn't doing well, and the bond market wasn't doing well.
I think we're at yields now, where the bond market can provide a good return, and particularly a bit of shelter should the equity market not perform well. That would likely be because the economy disappoints on the growth side. That will mean that interest rate cuts could come faster and the bond market provides more of an offset.
So I think at this point, that traditional balanced portfolio offers the kind of shelter from market volatility in a way that maybe it didn't when interest rates were climbing sharply back a year or two ago. So we do see some opportunities for bond yields to come down too, some decent returns there.
I think in the equity market, obviously, you know, we've had some very good years, particularly on the US side, maybe the technology side has done a lot of what it can do in the near term. So I'd be a bit cautious there. But longer-term and economic recovery in 2025 should give us another leg higher for stocks. And so it's just a matter of timing, as opposed to anything more dramatic.
Carissa: Yeah, time in the market and definitely a balanced strategy, will help weather some of the storm or any storm for the rest of 2024 and onwards. So before our chat today, I Googled, “What are Canadians asking about the economy in 2024?” And here's what I got: Will inflation go down in 2024? How much will it cost to live in Canada in 2024? And where does Canada's economy rank in the world?
Now there was a long list of questions, but Canadians are really paying close attention to what is unfolding, and to try to manage their overall financial well being. So Avery, where are interest rates headed? I know, you know, we have another announcement at the end of July. And in your opinion, what are the few things Canadians should stay close to?
Avery: I mean, in terms of interest rates, you don't want to get into the weeds of trying to predict exactly when the Bank of Canada will cut by exactly that much. I think if we step back and look at the big picture on overnight interest rates, around 3%, or maybe a shade under is a more normal position for the Bank of Canada. So that's not the lowsest interest rates we had in the last cycle or during the pandemic when we had rates near zero.
But we do expect that overnight rate of interest to get down to 3% or a shade under and 10 year interest rates, somewhere between three and a quarter and three and a half that's on government bonds. So all a bit lower than we are now and certainly short term rates quite a bit lower than we are now by the end of 2025. That's the way I would look at it. And as far as Canadians thinking about the economy, yes, inflation has been a concern.
But remember that wage increases often play catch up to inflation. And that has been what we've seen over the past year or so Canadians have actually gotten larger wage increases. To some extent that's because of inflation. And that is allowing the typical worker to actually play catch-up to where prices have gone.
So the purchasing power of the average wage, for example, has actually been recovering. So we shouldn't fear that inflation has really wiped us out in terms of buying power, at least for the typical worker. So there's some positives there.
But as far as Canada's economic performance, it really hasn't been great, particularly on a per capita basis. I think we need to see an improvement in output per hour or productivity that we have been seriously lacking over the last year or two and even on a longer term basis. We need to get businesses out there investing and expanding in Canada.
So there's certainly challenges ahead in terms of our medium term standard of living. We haven't done not well in the last couple of years, particularly compared to the Americans. And so we're hoping that that combination of a better global economy in 2025, and perhaps some targeted policy changes can bring us some joy on that front as well.
Carissa: Thank you. Thanks so much, Avery for this great economic update very timely. And as always, thank you for sharing your expertise.
Avery: You're welcome.
Carissa: For the latest commentary and analysis on Canada's economy from Avery and the Capital Markets team, check out the CIBC capital markets insight hub on our website. Thank you for tuning into this episode of Smart Advice. I'm Carissa Lucreziano. If you enjoyed this episode and found our latest economic insights valuable, feel free to share it with your social network. To make sure you never miss an episode, follow Smart Advice on your favorite podcast platform. For more financial tips, visit cibc.com/smart advice.