Bank of Canada Rate Decision Preview:  Inflation worries and the zero bound

• No change expected in policy interest rate of 0.25%.
• August jobs report in line with expectations, positive for the fourth month.
• More than half of pandemic job losses have been recovered.
• Canadian Dollar reverses near 2020 high, falls below 1.3200 on oil plunge.

At its September meeting on Wednesday, the Bank of Canada is widely expected hold the policy rate at 0.25% and permit inflation a wider latitude effectively pinning rates at the zero bound for the foreseeable future.  Governor Tiff Macklem has recently indicated that the bank would not increase rates until 2023.

The Canadian Dollar had touched 1.2994 last Tuesday, its highest point against its US counterpart since January 8, but a combination of revived resistance at 1.3000 and improving US statistics had stalled the pair there for a week. The 7.37% fall in WTI Crude on Tuesday to close at $36.84, capping a 13.8% drop this month pushed the USD/CAD over a figure higher closing Tuesday at 1.3239 its best finish since August 18.

CNBC

Canada employment

Canada shed just over 3 million jobs during the March and April shutdowns but since then 1.9 million of those layoffs, 63.5%, have been made good.  August’s gain of 245,800, slightly less than the 275,000 forecast, was the fourth positive month in a row that has brought the unemployment rate to 10.2% from 13.7% in May.

Canada employment change

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In contrast the US economy has reconstituted less than half, 47.8% (10.595 million of 22.160 million) of its non-farm payrolls losses through August. But the American unemployment rate is almost two points lower at 8.4% down from a high of 14.7% in April. 

Purchasing managers’ index

Early data for August shows the Canadian economy continuing to expand. The Markit manufacturing PMI rose to 55.1 from 52.9 in July with the best score since August 2018.  The result reversed the forecast drop to 50.4.  The index from the Richard Ivey School of Business in Ontario slipped slightly to 67.8 in August from 68.5in July but it was far above the expected level of 57.5 and the second strongest score since April 2018.

CPI

Canadian consumer prices had took a sharp fall during the pandemic lockdowns.  Overall CPI annual dropped from 2.2% in February to -0.4% in May and though prices recovered to 0.7% in June the July drop to 0.1% was well below the consensus of 0.5%.  Likewise the core progression is not comforting. From 1.8% in February the core rate hit 0.7% in May and the subsequent rise to 1.1% in June reversed to 0.7% in July.

Core CPI

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The evident weakness in inflation despite the steady recovery of the job market and economic growth is a sign that demand is not sufficient to restore prices to their pre-shutdown levels.  

Conclusion

Despite the largely successful recovery of the Canadian economy from the artificial disaster of the closures a number of factors will keep the BOC at the zero rate boundary for several years.  Like the Fed the bank is likely to elaborate this policy at this meeting or soon. 

The employment recovery is relative. Over one-third of laid off workers are still unemployed. At some point the economy will reach a point where the remaining layoffs are due to the failure of many business during the long shutdown.  It may be years before the economy is robust enough to create replacements. 

The tenuous nature of the recovery in Canada is duplicated in much of the world and in the United States, her largest market.  Consequently the demand for Canadian resources is likely to remain substandard.  The recent collapse in crude oil is one sign of that weakness.

Finally the inability of central banks to lift inflation to their targets, not only in Canada but globally will give the governors ample logic to emulate the Federal Reserve.  Lower rates for longer. What was always a de facto rate policy will become de jure.  As more and more central banks succumb to this reality the trading balance will begin to shift back to the US dollar.  The recent reversal in the loonie suggests more losses ahead.