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Weekly Commentary

Did You Hear That Sigh of Relief?

November 10, 2022

Jimmy Jean,
Vice-President, Chief Economist and Strategist

Positive surprises on inflation reports have been a rare occurrence lately. That’s why markets are cheering the lower-than-expected US inflation reading. At 7.7%, inflation came in below even the most conservative of the forecasts compiled by Bloomberg. The previously stubborn core inflation measure eased to 6.3% from 6.6%, which is encouraging. On an even more positive note, the three-month annualized measure of core inflation decelerated to 5.8%, which suggests that we should continue to see inflation cool.

It could still be a slow process. Even if supply chain pressures have been easing, along with global food and energy commodity prices, some academic literature suggests that full transmission from these types of shocks can take up to a year to get fully reflected into consumer prices.

That said, Fed officials are aware of the lags and October’s positive surprise should give them a bit of reassurance. Just last week, the strong October jobs report gave the impression that the US job market still has plenty of momentum. Indeed, despite the layoffs in sectors like tech, construction and recreation that have been making headlines throughout the year, we’ve seen payrolls swell by 4M in 2022 so far. This is supposed to be positive news, but it isn’t so when we have an overheated job market and the Fed is trying to cool demand. So, despite the red hot labour market, the fact that inflation might be starting to behave as hoped comes to reinforce our view that the Fed will be dialing down the pace of hikes starting next month.

Canada’s CPI report will be out next Wednesday. Stickiness in core measures of inflation has been a concern for the Bank of Canada north of the border as well but like for the US, trends in short-term core inflation is what we should be paying more attention to. On this front, some cooling has already been observed and we will assess whether that momentum continues.

While the blowout jobs report for October had given a brief scare as to the Bank of Canada’s policy trajectory, the improvement was accompanied by a strong uptick in the participation rate, leaving the unemployment rate unchanged. As a result, unless we see a major unwelcome surprise in CPI, the Bank of Canada should also be on track to slow the pace of tightening, with a 25bps hike in December. This would make it the smallest rate hike since March.

Importantly that’s assuming that fiscal policy doesn’t muddle things. From that perspective, the Fed can probably rest a bit easier than the Bank of Canada. The midterm elections look likely to result in a divided Congress, which will assuredly prevent major policy initiatives. That would have been a disheartening story during the 2010s decade but this “discipline via dysfunction” is actually helpful in the current context. And of course, Democrats haltingly enacted their large pieces of economic legislation during the two-year window where they were in control of Congress, meaning that the long-term public investment imperatives are being addressed.

It’s a bit of a different context in Canada. Chrystia Freeland’s fall economic statement managed to show the necessary solidarity with those that are the most distressed by cost-of-living pressures, yet without the kind of fiscal recklessness that has been seen elsewhere. Chrystia Freeland has explicitly vowed not to complicate the Bank of Canada’s job.

However, that sort of coordination between fiscal and monetary policymakers goes out the window when we get to the provincial level. Given the political pressure to address affordability via expansionary fiscal policy, the upcoming provincial fiscal updates will be a relevant input to our interest rates outlook.

Ontario will be tabling its update next Monday. As far as affordability relief is concerned, it has been among the most parsimonious provinces, with only incremental affordability measures so far announced since the province’s spring budget. That could change, as the government is under pressure to redistribute what will be another colossal revenue windfall. Alberta’s windfall is even more dramatic, as the province is currently projecting the largest surplus in the recorded history of any Canadian province. The government has focused on debt repayment thus far but Premier Danielle Smith signaled this week that more affordability relief was on the way.

Quebec is expected to present its update in early December and the new round of cheques promised by the CAQ party during the recent election campaign will likely be formalized. At 1% about of nominal GDP this year according to the financial framework released by the CAQ during the election, Quebec’s proposed affordability relief measures would make it among the most generous provinces on that front.

However, our forecast for Canada to experience a mild recession in early 2023 implies that all provinces will need to brace for deterioration to their bottom lines. Improperly calibrated affordability measures can make matters worse, not only via the increase in spending but with the more aggressive monetary policy response that would ensue.

This would in turn cause a more severe recession, hitting government revenues, possibly raising fiscal sustainability concerns, and in the end inhibiting governments’ ability to support the recovery via supply-oriented policy measures.

Focus on bolstering supply happens to be the best contribution governments can make to the inflation fight. Let’s hope that the fiscal updates show they’ve gotten that message loud and clear.

Read the full commentary: Did You Hear That Sigh of Relief?