Spring housing market resurgence could give Bank of Canada pause on rate cuts

A cut in April ‘would be about the dumbest thing the central bank could do,’ Scotiabank’s Derek Holt says

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Most economists agree that it’s just a matter of time before the Bank of Canada cuts interest rates. But, as the bank prepares to unveil its latest rate decision on Wednesday, at least one is warning that the potential for a hot spring housing market and a stimulative federal budget could push the timeline for those cuts back to the fall.

While some economists have predicted a spring cut from the current five per cent overnight rate, Derek Holt, head of capital markets economics at Bank of Nova Scotia, said a trim in April “would be about the dumbest thing the central bank could do.”

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“It would be pretty awkward for the Bank of Canada to decide to cut into what I think is going to be a hot spring housing market with another round of stimulative government budgets that heap on more spending,” Holt said.

He’s equally skeptical about a June cut, which he says is already baked into the market and consensus forecasts.

“Our forecast is for the first cut to be delivered in September,” he said, adding that he believes softness in core inflation in January was temporary and will rebound.

“If they cut in (the) spring … I fear it would be a sharp policy error that would thwart prospects for greater policy easing later,” he said. “Patience may pay if they hold off to evaluate conditions and are ideally able to deliver more meaningful and persistent easing later.”

The view that there could be a cut as early as April is predicated on the belief that the central bank will ignore the effects of shelter price inflation, which is holding consumer price index growth above the bank’s target of two per cent.

“There’s been plenty of chatter about the Bank of Canada perhaps looking through shelter inflation due to the surge in rent and mortgage interest costs,” said Doug Porter, chief economist at Bank of Montreal, adding that he doesn’t think it will happen.

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The argument goes that there is nothing the central bank can do to control population growth and its impact on rent and mortgage interest costs, but since rent and ownership costs are rising at a similar pace, “it’s not just interest rates (that are) driving the boat” on shelter inflation, Porter said.

“Ignoring such a large portion of household expenses while inflation expectations remain elevated could potentially further jeopardize the Bank of Canada’s credibility,” he said.

A June start to rate cuts is Porter’s base assumption — in line with the forecast of economists at Royal Bank of Canada — so long as disinflationary trends continue between now and then. But he thinks there will be a shift in tone in the Bank of Canada’s March 6 rate-setting announcement.

“The tone of the statement is expected to be a tad more dovish as the bank acknowledges the better inflation figures,” he said, adding that while fourth quarter GDP growth came in a bit firmer than they had anticipated, it remains below potential, driving more disinflationary pressure that is consistent with the Bank of Canada’s broader forecast.

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“Nonetheless, don’t expect a clear indication that rate cuts are at all imminent,” Porter said.

Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said there’s little suspense ahead of the March 6 announcement because the Bank of Canada will want to wait for April’s monetary policy report before signalling its next move.

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“The bank is clearly not ready to move just yet, and likely wants to have a new economic forecast in hand … before any material change to its messaging,” Shenfeld said.

Canada’s central bank has the luxury of waiting longer than the United States Federal Reserve to make cuts due to a lower policy rate and undervalued currency, said Holt, the Bank of Nova Scotia economist.

“The Bank of Canada can lag the Fed as it evaluates what I think are higher inflation risks north of the border than in the U.S.,” he said. “Wage growth is sharply accelerating, productivity is tanking, fiscal stimulus continues to be applied, and immigration is excessive relative to the ability to absorb this many people into a tight housing market.”

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