Photo by Michelle Spollen on Unsplash

Central bankers are loath to act quickly, even in the face of mounting evidence that the inflation of 2020-23 is no longer hitting the consumer. The trend over the past 12 months has been unmistakable, as disinflationary forces take hold in the major industrial nations. Added is the presence of near zero price change in China as that economy slows down. It is no exaggeration to claim that the pandemic-influenced inflation is no longer affecting our economies. Disinflationary forces began over a year ago when inflation was running in excess of 5%, only to tumble to 2% or less last month.September’s CPI in Canada fell to 1.6%, well below the 2% measure that is so widely used as a target for setting monetary policy. Just like one swallow does not make a spring, one month’s inflation number below 2% does not signal that inflation is no longer a threat. But the trend is unmistakable that inflation has been steadily reduced, month by month, since the start of the year. 

Figure 1 CPI Rates in US, Canada and EU

What has been the reaction in the debt markets to the steady drumbeat of disinflation in Canada?  

To begin with, the Bank of Canada was very reluctant to lower its overnight or policy rate from its height of 5% a year ago. It was slow off the mark and only started to cut rates in its last three meetings, but the cuts were in small incremental amounts of 25bps each time. It was a signal, but hardly market moving, especially in the all-important 5-year bond market which determines mortgage rates. Canada’s 5yr- bond started out the new year of 2024 at just shy of 4% and now trades are just under 3%. As a result, there has been very little relief in the mortgage market and a consequence Canada’s home sales have been weak during the year.

Furthermore, the Canadian economy remains weak as GDP growth per capita declined this year. The disinflation confirms the weakness and puts considerable pressure on the central bank to act more boldly. The major Canadian commercial banks in a show of unity have issued forecasts calling for a 50bp reduction in the Bank rate if there remains any expectation of an economic revival. The international market has taken notice of Canada’s weakness. The Canadian dollar has been selling off and now trades as low as C$1.38, some 5% off its high in January 2024. Should the Bank of Canada cut a full 50bps in its meeting next week, currency traders will respond with a further sell off in the Loonie. Nevertheless, the current level of the Bank rate is no longer justified and requires that the Bank of Canadabe more proactive to save the economy from its current lackluster performance.  

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