Wage inflation, US economy key focuses for BoC going forward

BMO economist highlights why he believes cuts won't happen until September

Wage inflation, US economy key focuses for BoC going forward

The Bank of Canada (BoC) may have made its first clear signal to cut yesterday. After announcing that its key interest rate would be held steady at five per cent, BoC Governor Tiff Macklem may have offered a glimmer of hope that cuts will come, provided economic data continues to trend in the directions he wants.

Earl Davis, head of fixed income and money markets at BMO Global Asset Management (GAM) says prior to Wednesday’s meeting, the BoC’s messaging was that they were still adamant on being cautious and they weren't considering eases, Davis says.

“They would first have to allude to the possibility of eases before they ease. There would be one statement in between that would open up the possibility for eases, we got that today,” Davis says. “In the Q&A, where someone asked if the possibility of an ease in June was open, Governor Tiff Macklem’s response was, ‘It's in the realm of possibilities.’”

However, Davis believes that investors will have to wait a little longer than June before the industry sees any easing. He notes that Canadian CPI is trending downwards, but wage inflation and other inflationary factors could still pose risks in Macklem’s view. US inflation is a risk, too. Wednesday’s higher-than-expected US CPI print which has moved most expectations of possible interest rate cuts in the United State  from June to September. Because there's no market expectation of an ease in the US in June, if Canada were to start easing before the US Federal Reserve does, it would have “significant implications on the currency.”

“It would weaken the Canadian currency, which in and of itself, there's a plus and a minus to it,” he says. “The plus side to having a weakening Canadian currency is it should increase cross-border trade with the US, because we become a cheaper option. The minus side of it is it would increase inflation, because imported goods would become more expensive here.”

The BoC signalled inflation might be cooling faster than previously expected in an updated monetary policy report released on Wednesday. “We’ve hit all the qualifications for them to ease, they just want them to ensure that they’re sustained to allow them to ease, so that was a significant pivot in their language,” Davis added. “CPI prints are lower than expected, which is good thing, they have to let the market knows now they’re considering eases.”

Going forward, Davis pointed out that the BoC will focus on three things: core inflation, unemployment rate and wage inflation.

“The number one thing is wage inflation,” says Davis. This lines up with recent data as unemployment numbers in the country are below five per cent but wage inflation is somewhat elevated at 3.9 per cent. A target for reasonable wage inflation, is three per cent, added Davis. “Even though CPI is coming down, they're looking at both CPI and its impact on wage inflation. They want to have confidence in one of [those] two things.”

Davis says despite the decision, Canadian stocks will do alright. After all, many Canadian stocks are ties to commodities like oil & gas which are currently moving higher, a benefit to Canada’s stock markets, Davis noted.

“The other thing is in the US, they're not just talking about the resiliency of the US economy, they're talking about the re-acceleration of the US economy,” he says. “The reacceleration of US economy is beneficial to the financial institutions in Canada, because they have significant exposure in the US. They will benefit from that, and they will do well.”

The outcome to hold interest rates means a growing divergence between Canada and the US for asset managers noted Davis, and it’s important to be able to discern between the tide and the waves.

“The US market is the tide and the Canadian market…is the waves. You have to be able to discern when you want to put your boat in the water. You want to put it in at high tide, regardless of the waves. The tide is coming in now in regard to higher yields, because of today's [US] CPI number, and because of the repricing of interest rates and Fed expectations, which allows for a great opportunity to extend duration shortly.”

RELATED ARTICLES