The Bank of Canada's job just got a little tougher.
Yesterday, Bank of Canada Governor Tiff Macklem spoke about wages and productivity. He dismissed stickier wage data:
"Depending on the measure you look at, wage growth peaked at between 4½% and 6%. This was roughly twice the pre-pandemic average of 2% to 3%. With inflation now much lower and the labour market rebalancing, we are starting to see evidence that wage growth is moderating. The latest numbers on a six-month basis suggest wage growth has eased to about 4%. This is clearly down from the peak, but still above the pre-pandemic average."
He highlighted that wages lag and that there have been occupational shifts. He also highlighted rapidly-rising unemployment among new immigrants.
Both that measure and unemployment among young workers are above pre-pandemic levels.
I take those messages as a sign the Bank of Canada is inching towards cutting rates in July but today's data calls that into question. CPI rose 2.9% y/y compared to 2.6% expected and 2.7% in the prior month. Core measures were also mostly hotter with rents running particularly hot and travel tours adding to inflation.
The market certainly noticed with probabilities for the July 24 meeting now at 53% compared to 71% before the data.
Normally, that would lead to a strong currency bump but the Canadian dollar rose only modestly. USD/CAD is trading at 1.3651 compared to 1.3675 before the data after initially falling to 1.3615.
Why has the loonie failed to follow through on the move? I tend to think of inflation as yesterday's story. The rising unemployment in various sectors in Canada combined with flagging retail sales highlight an economy that's being squeezed by high interest rates. Yesterday Macklem highlighted that only about half of mortgage holders in Canada have been hit by higher rates as 5-year resets roll off. Every day, more roll over and the spreads are wide and set to widen as those with ultra-low rates are hit through 2026.
I don't believe the market has priced in that headwinds, which will still hit hard even if rates come down by 200 basis points.
To summarize: The trade on the Canadian dollar right now isn't interest rate differentials, it's growth. Rates might stay higher for a bit longer but growth is rapidly cooling and there is a rising chance of a recession, particularly if the Bank of Canada doesn't cut rates.
Said differently, the BOC will either cut steadily and shallowly now, or more-deeply and rapidly later. The market will ultimately shift its focus beyond the next meeting and to the deeper, long-term problems that are emerging in the Canadian economy.
I spoke about this recently with BNNBloomberg:
