We expect the policy rate to fall to 2.50% by the spring of next year. This morning’s 50 bp cut reinforces speculation of another 50 bp move in December. However, the Bank will likely need to see continued weak economic data and low inflation to prompt another big move. Wage growth remains stubbornly strong, and there might be some lingering concern about reigniting the housing market, especially with mortgage insurance rules poised to change on December 15.

However, the Bank pointed out that lower rates will trigger a rebound in the housing market. According to the Monetary Policy Report (MPR), “Resales and renovations are anticipated to recover as interest rates decline. Renovations should also be supported by a projected rise in house prices. Recent changes to government mortgage insurance rules are expected to bolster housing demand. Although population growth should ease, the level of demand is expected to remain robust and support new construction. Lower interest rates may also facilitate some increase in housing supply by easing financing costs. However, constraints on the amount of land available for new homes, zoning restrictions and a lack of skilled labour are expected to limit the pace of construction, particularly over the near term. As a result, growth in housing demand is expected to outpace increases in supply. Unlike other sectors of the economy that are experiencing excess supply, the housing market is projected to remain tight. House prices are expected to rise, but the pace of increases will likely be restrained because some home buyers will face affordability challenges”.

Effective tomorrow, the prime rate will fall to 5.95%, lowering floating-rate mortgage rates. According to Mortgage Logic News, the lowest nationally advertised 5-year fixed rate is down 10 bps this week to 4.09%.

In its policy statement, the Governing Council reduced its forecast for growth in the second half of this year to 1.75%. Third-quarter GDP growth was revised to 1.5% from 2.8% in the July MPR. Inflation has improved faster than expected, ending the year at 2.1%, with core inflation at 2.3% and falling further in 2025.

Today’s action is great news for the Canadian economy and housing activity. Market participants are now expecting home resales to pick up sharply in the first quarter of next year. The coming spring housing season should be robust, boosting sales and prices.

Tiff Macklem said today, “If inflation continues to ease broadly in line with the central bank’s July forecast, it is reasonable to expect further cuts in the policy rate. We will continue to assess the opposing forces on inflation and take our monetary policy decisions one at a time.”

The economy grew by 2.1% in the second quarter, led by government spending and business investment. This was slightly stronger than forecast in July. Together with the first quarter’s growth of 1.8%, the economy grew by about 2% over the first half of 2024. That’s a healthy rebound from our near-zero growth in the second half of 2023. The Bank’s July projection has growth strengthening further in the second half of this year. Recent indicators suggest there is some downside risk to this pickup. In particular, preliminary indicators suggest that economic activity was soft through June and July, and employment growth has stalled in recent months.

That makes this Friday’s Labour Force Survey data for August particularly important. We expect economic activity to slow in the third quarter to rough 1.3%, keeping the Bank in an easing posture through next year.

The unemployment rate has risen over the last year to 6.4% in June and July. The rise is concentrated in youth and newcomers to Canada, who find it more challenging to get a job. Business layoffs remain moderate, but hiring has been weak. The slack in the labour market is expected to slow wage growth, which remains elevated relative to productivity.

Turning to price pressures, CPI inflation eased further to 2.5% in July, and the central bank’s preferred measures of core inflation also moved lower. With the share of CPI components growing above 3% around its historical norm, there is little evidence of broad-based price pressures. But shelter price inflation is still too high. Despite some early signs of easing, it remains the most significant contributor to overall inflation. Inflation remains elevated in some other services but has declined sharply in manufacturing and goods prices.

As outlined in the Bank of Canada’s Monetary Policy Report, inflation is expected to ease further in the months ahead. It may bump up later in the year as base-year effects unwind, and there is a risk that the upward forces on inflation could be more potent than expected. At the same time, with inflation getting closer to the target, the central bank must increasingly guard against the risk that the economy is too weak and inflation falls too much. Judging from comments made at today’s press conference, the BoC is at least as concerned about too much disinflation–taking the economy into a deflationary spiral.

Macklem said, “We are determined to bring inflation down to the 2% target and keep it there. We care as much about inflation being below the target as we do about it being above it. The economy functions well when inflation is around 2%.”

With continued easing in broad inflationary pressures, the Governing Council reduced the policy interest rate by 25 basis points. Excess supply in the economy continues to put downward pressure on inflation, while price increases in shelter and some other services are holding inflation up. The Governing Council is carefully assessing these opposing forces on inflation. “Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook. The Bank remains resolute in its commitment to restoring price stability for Canadians”.

Monetary policy remains restrictive, as the chart above shows. While the target overnight rate is now 4.25%, core inflation is only roughly 2.4%. Real interest rates remain too high for the economy to reach its potential growth pace of about 2.5%. Weaker growth implies a continued rise in unemployment and excess supply in other sectors.

In separate news, the US released data showing that US job openings fell to their lowest level since January 2021, consistent with other signs of slowing demand for workers.

US job growth has been slowing, unemployment is rising, and job seekers are having greater difficulty finding work, fueling fears about a potential recession.

Federal Reserve policymakers have made it clear they don’t want to see further cooling in the labour market and are widely expected to start lowering interest rates at their next meeting in two weeks.

In other news, consistent with a global economic slowdown, oil prices have plunged to new 2024 lows. Weak oil prices are a harbinger of lower inflation, growth and mortgage rates.

Bonds rallied in the wake of the disappointing US data, taking the 5-year government of Canada bond yield down to a mere 2.89%, well below the 3.4% level posted when the Bank of Canada began cutting interest rates in June. This decline in market-driven interest rates reduces fixed-rate mortgage yields. Moreover, today’s cut in the overnight rate will be followed soon by a 25 basis point reduction in the prime rate to 6.45%, reducing floating rate mortgage yields as well.

The Bank of Canada has two more decision dates this year: October 23 and December 11. At those meetings, the Bank is widely expected to continue its quarter-point rate cuts, taking the overnight rate down to 4.0% at year-end and 2.75% next year.

“It wasn’t a ‘blow the doors off’ month by any means, but Canada’s housing numbers did perk up a bit on a month-over-month basis in June following the first Bank of Canada rate cut,” said Shaun Cathcart, CREA’s Senior Economist. “Year-over-year comparisons don’t look great mainly because of how many buyers were still jumping into the market last spring, but that’s a story about last year. What’s happening right now is that sales were up from May to June, market conditions tightened for the first time this year, and prices nationally ticked higher for the first time in 11 months”.

As the national increase in new listings was smaller than the sales gain in June, the national sales-to-new listings ratio tightened to 53.9% compared to 52.8% in May. The long-term average for the national sales-to-new listings ratio is 55%, with a sales-to-new listings ratio between 45% and 65%, generally consistent with balanced housing market conditions.

“The second half of 2024 is widely expected to see the beginnings of a slow and gradual return of buyers into the housing market,” said James Mabey, Chair of CREA. “Those buyers will face a considerably different shopping experience depending on where they are in Canada, from multiple offers in places like Calgary to the most inventory to choose from in over a decade in places like Toronto.

At the end of June 2024, there were 4.2 months of inventory nationwide, down from 4.3 months at the end of May. This was the first time that the number of months of inventory had fallen month over month in 2024. The long-term average is about five months of inventory.

The National Composite MLS® Home Price Index (HPI) increased by 0.1% from May to June. While a slight increase, it was noteworthy because it was the first month-over-month gain in 11 months. Regionally, prices are still generally sliding sideways across much of the country. The exceptions remain Calgary, Edmonton, and Saskatoon, and to a lesser extent Montreal and Quebec City, where prices have steadily increased since the beginning of last year.

That said, there have been more recent upward price movements in other markets, including across Ontario cottage country, Mississauga, Hamilton-Burlington, Kitchener-Waterloo, Cambridge, London-St. Thomas, and Halifax- Dartmouth.

The non-seasonally adjusted National Composite MLS® HPI stood 3.4% below June 2023. This mostly reflects how prices took off last April, May, June, and July – something that has not been repeated in 2024.

Housing activity will gradually accelerate over the next year as interest rates continue to fall. Yesterday, bond yields fell considerably due to the marked improvement in the June US inflation data. Markets are now pricing in a 90% chance of a Federal Reserve rate cut in September, allaying fears that the Canadian dollar will decline precipitously if the Bank of Canada continues to go it alone in easing monetary conditions.

Next week’s CPI data will determine whether the Bank of Canada cuts rates at their July confab or waits until the September meeting. A further reduction in core inflation will open the doors to another rate cut on July 24, particularly given the continued rise in the Canadian unemployment rate. Rising monthly mortgage payments in the wake of record renewals will continue to slow discretionary consumer spending, providing further impetus for Bank of Canada rate cuts.

Canada shed 1,400 jobs last month, following a 26,700 increase in May. Economists had been expecting a stronger showing. Monthly job gains have averaged around 30,000 in the past year, while labour force growth has been more than 50,000, causing the jobless rate to rise. Full-time jobs declined marginally while part-time work edged upward. Job losses in June were led by decreases in transportation and warehousing, information and recreation, and wholesale and retail trade.

Regionally, jobs decreased in Quebec but rose in New Brunswick and Newfoundland and Labrador.

Average hourly wages among employees increased 5.4% in June on a year-over-year basis, following growth of 5.1% in May (not seasonally adjusted). This won’t sit well with the central bank’s Governing Council, but they realize that wage inflation is a lagging economic indicator, and rapidly rising unemployment will ultimately dampen wage inflation.

The data were released at the same time as US payrolls, which showed hiring moderated in June and prior months were revised lower. This boosts the odds that the Federal Reserve will begin to cut interest rates in the coming months. Fluctuations in the loonie are often driven by the difference between US and Canadian interest rates, owing to the two countries’ tight economic links.

Traders in overnight swaps increased their bets that the Bank of Canada will cut borrowing costs again in July, putting the odds at around two-thirds, up from around 55% before the release.

In a speech last week, Macklem said it’s “not surprising” that wages are moderating more slowly than inflation because wages tend to lag the trend in job growth. He also said the unemployment rate could rise further, but a significant increase isn’t needed to get inflation back to the 2% target.

With the Bank of Canada rate cut on June 5, housing activity will likely perk up in the coming months. The central bank will likely reduce the overnight policy rate from 4.75% to 3.0% by the end of next year. While interest rates will remain above pre-pandemic levels, there is pent-up demand for housing, and activity will surely rise over the next year.

The number of newly listed homes was up in May, though only by 0.5% monthly. Slower sales amid more new listings this year have increased the number of homes for sale across most Canadian housing markets.

As of the end of May 2024, about 175,000 properties were listed for sale on all Canadian MLS® Systems, up 28.4% from a year earlier but still below historical averages.

“The spring housing market usually starts before all the snow has melted, somewhere around the beginning of April, but this year I believe a lot of people were waiting for the Bank of Canada to wave the green flag,” said James Mabey, Chair of CREA. “That first rate cut is expected to bring some pent-up demand back into the market, and those buyers will find there are more homes to choose from right now than at any other point in almost five years.”

With sales down slightly and new listings up slightly in May, the national sales-to-new listings ratio eased to 52.6% compared to 53.3% in April. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions. There were 4.4 months of inventory on a national basis at the end of May 2024, up from 4.2 months at the end of April and, looking past the volatility at the onset of the COVID-19 pandemic, the highest level for this measure since the fall of 2019. The long-term average is about five months of inventory.

The National Composite MLS® Home Price Index (HPI) dipped 0.2% from April to May.

Regionally, prices are generally sliding sideways across most of the country. The exceptions remain Calgary, Edmonton, and Saskatoon, where prices have steadily ticked higher since the beginning of last year.

The non-seasonally adjusted National Composite MLS® HPI stood 2.4% below May 2023. This mostly reflects the price surge that started last April and hasn’t been repeated in 2024.

Housing activity will gradually accelerate over the next year as interest rates continue to fall. The Bank of Canada was the first major central bank to ease monetary policy. While there has been some concern regarding the impact on the Canadian dollar of repeated easing by the Bank with the US Federal Reserve on hold, the divergence may be smaller than expected. Recent US inflation data showed a meaningful improvement, suggesting the Fed could cut rates two times before the end of the year. Moreover, movements in the loonie have little near-term impact on inflation.

The Canadian economy is far more interest-sensitive than the US, and the relative underperformance of our economy is the largest since 1965. Further rate cuts by the Bank of Canada are warranted.

A Collective Sigh of Relief As The BoC Cut Rates For the First Time in 27 Months

With continued evidence that underlying inflation is easing, the Governing Council agreed that monetary policy no longer needs to be as restrictive. Recent data has increased our confidence that inflation will continue to move towards the 2% target. Nonetheless, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

As shown in the second chart below, the nominal overnight rate remains 215 basis points above the current median CPI inflation rate, which shows how restrictive monetary policy remains. The average of this measure of real (inflation-adjusted) interest rates in the past 30 years is just 60 bps. The overnight rate is headed for 3.0% by the end of next year.

There are four more policy decision meetings before the end of this year. It wouldn’t surprise me to see at least three more quarter-point rate cuts this year. While the overnight rate is likely headed for 3.0%, it will remain well above the pre-COVID overnight rate of 1.75% as inflation trends towards 2%+ rather than the sub-2% average in the decade before COVID-19.