Inflation Cooled Again in August, But Higher Rates Still Coming

Canada’s headline inflation rate cooled again in August, even a bit more than expected. The consumer price index rose 7.0% from a year ago, down from 7.6% in July and a forty-year high of 8.1% in June, mainly on the back of lower gasoline prices.

The CPI fell 0.3% in August, the most significant monthly decline since the early months of the COVID-19 pandemic. On a seasonally adjusted monthly basis, the CPI was up 0.1%, the smallest gain since December 2020. The monthly gas price decline in August compared with July mainly stemmed from higher global production by oil-producing countries. According to data from Natural Resources Canada, refining margins also fell from higher levels in July.Transportation (+10.3%) and shelter (+6.6%) prices drove the deceleration in consumer prices in August. Moderating the slowing in prices were sustained higher prices for groceries, as prices for food purchased from stores (+10.8%) rose at the fastest pace since August 1981 (+11.9%).

Price growth for goods and services both slowed on a year-over-year basis in August. As non-durable goods (+10.8%) decelerated due to lower prices at the pump, services associated with travel and shelter services contributed the most to the slowdown in service prices (+5.5%). Prices for durable goods (+6.0%), such as passenger vehicles and appliances, also cooled in August.

In August, the average hourly wages rose 5.4% on a year-over-year basis, meaning that, on average, prices rose faster than wages. Although Canadians experienced a decline in purchasing power, the gap was smaller than in July.

Core inflation–which excludes food and energy prices–also decelerated but remains far too high for the Bank of Canada’s comfort.  The central bank analyzes three measures of core inflation (see the chart below). The average of the central bank’s three key measures dropped to 5.23% from a revised 5.43% in July, a record high. The Bank aims to return these measures to their 2% target.

Bottom Line

Price pressures might have peaked, but today’s data release will not derail the central bank’s intention to raise rates further. Markets expect another rate hike in late October when the Governing Council of the Bank of Canada meets again. But further moves are likely to be smaller than the 75 bps-hikes of the past summer.

There is still more than a month of data before the October 25th decision date. The September employment report (released on October 7) and the September CPI (October 19) will be critical to the Bank’s decision. Right now, we expect a 50-bps hike next month.

Housing Soften Again in August

The full effects of the most recent rate hikes have not yet manifested. Statistics released today by the Canadian Real Estate Association (CREA) show that the slowdown that began in March in response to higher interest rates continued in August, albeit at a slower pace. Home sales recorded over Canadian MLS® Systems fell by 1.0% between July and August 2022. The pace of home sales last month was well below its 10-year moving average as buyers and sellers moved to the sidelines in response to rising mortgage rates and a reassessment of the outlook. While this was the sixth consecutive month-over-month decline in housing activity, it was also the smallest of the six.

It was close to an even split between the number of markets where sales were up and those where sales were down. Gains were led by the Greater Toronto Area (GTA) and a large regional mix of other Ontario markets. These were offset by Greater Vancouver, Calgary, Edmonton, Winnipeg, and Halifax-Dartmouth declines.

The actual (not seasonally adjusted) number of transactions in August 2022 came in 24.7% below the same month last year. While still a large decline, it was smaller than the 29.4% year-over-year drop recorded in July.

While some suggest that the worst of the housing correction might be behind us, recent data suggests that those sentiments are premature. The August inflation data for the U.S., released this past Tuesday, were considerably stronger than expected, especially for inflation excluding energy. To be sure, commodity prices have fallen sharply in recent weeks, tempering headline inflation. But many other components of core inflation have proven to be very sticky. In consequence, market-driven interest rates have risen further, and next week it is widely expected that the Fed will hike the overnight rate by at least 75 bps.

In Canada, we will see the August CPI data next Tuesday. The Bank of Canada aims to hike the policy rate target when it meets again on October 25. In the past, it took overnight rates above the inflation rate to finally break the back of inflation. Bay Street has been revising up its estimates for the terminal policy rate target all week. I believe it will be well above 4.0%.

New Listings

Sellers are reticent to accept that the sky-high prices posted early this year are no longer clearing markets. Rather than rapid-fire turnover, newly listed properties remain on the market for much longer,  multiple-bidding situations are rare, and many successful buyers are adding financing conditions to their offers.

The number of newly listed homes fell to 5.4% on a month-over-month basis in August. This built on the 5.9% decline noted in July, as some sellers appear content to stay on the sidelines until more buyers are ready to get back into the market. The decline in new supply was broad-based, with listings decreasing in about 80% of local markets, including every large market except for Montreal, where new supply was mostly flat from July to August.

With sales little changed and new listings down in August, the sales-to-new listings ratio tightened to 54.5% compared to 52.1% in July. The August 2022 reading for the national sales-to-new listings ratio was very close to its long-term average of 55.1%.

There were 3.5 months of inventory on a national basis at the end of August 2022, up slightly from 3.4 months at the end of July. While the number of months of inventory remains well below the long-term average of about five months, it is also up quite a bit from the all-time low of 1.7 months set at the beginning of 2022.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) edged down 1.6% on a month-over-month basis in August 2022, not a small decline historically, but smaller than in June and July.

Breaking it down regionally, most of the monthly declines in recent months have been in markets across Ontario and, to a lesser extent, in British Columbia; however, in August, Ontario markets contributed most to the overall national decline.

Looking across the Prairies, prices in Alberta appear to have peaked. Prices still rise slightly in Saskatchewan, while Manitoba recorded the only decline. In Quebec, prices have dipped somewhat in the last couple of months. On the East coast, the softening of prices confined to Halifax-Dartmouth is now also appearing in New Brunswick, Newfoundland and Labrador. By contrast, prices in PEI continue to edge ahead on a month-over-month basis.

The non-seasonally adjusted Aggregate Composite MLS® HPI was still up by 7.1% on a year-over-year basis in August. This was the first single-digit increase in almost two years, as year-over-year comparisons have been winding down at a brisk pace from the near-30% record year-over-year gains logged just six months ago.

Bottom Line

The Canadian housing correction continues as the Bank of Canada aggressively tightens monetary policy. Using average benchmark prices by region, the first table above shows how much prices have fallen since their recent peak in March this year. For Canada, average prices have dipped 11.1%, led by the 13.7% decline in Greater Toronto. Greater Vancouver has posted an 11.7% drop. The second table shows that, despite these downdrafts, year-over-year price gains remain positive, reflecting the super-charged home price inflation from August 2021 to March 2022.

By the end of the first quarter of 2023, all the y/y appreciation will be obliterated. The 50% rise in home prices over the first two years of the pandemic was fuelled by record-low interest rates. The overnight rate was a mere 25 bps. It will soon be 400 bps. No wonder recent variable-rate mortgage buyers are beginning to confront their trigger points.

Job Market Weakens As Economy Slows

The August employment report, released this morning by Statistics Canada, was considerably weaker than expected. Higher interest rates have slowed the red-hot labour market. The Canadian economy shed 39,700  jobs in August, missing market expectations of a 15,000 rise and bringing cumulative declines since May 2022 to 113,500 (see chart below). The job losses were most significant in education and construction. Education employment in the summer months can be distorted by seasonal factors and changes in the start of the school year.

We know that residential construction projects have been postponed or cancelled owing to the rise in borrowing costs and the slowdown in home sales. There were also fewer workers in construction (-28,000; -1.8%) in August, with the decrease spread across several provinces, led by Alberta (-11,000; -4.6%) and Ontario (-10,000; -1.6%).Total employment fell in British Columbia, Manitoba, and Nova Scotia, while it increased in Quebec. There was little change in the other provinces.

Total hours worked were unchanged in August, following a decline in July (-0.5%). On a year-over-year basis, total hours worked were up 3.7%.

Hybrid Work Continues

Working from home continues to be an important feature of work for many Canadians, although the specific nature of the arrangement continues to shift. As of August, 16.8% of employed Canadians reported that they usually work exclusively from home, down from 18.0% in July and down 7.5 percentage points since the beginning of 2022. The proportion of workers with a hybrid work arrangement—those who usually work both at home and at locations other than home—increased by 0.7 percentage points to 8.6% in August.

The Unemployment Surged From Record Low

The unemployment rate was 5.4% in August, up 0.5 percentage points from the record low of 4.9% observed in June and July. This was the first increase not coinciding with a tightening of public health restrictions since May 2020, when the unemployment rate reached its pandemic peak.

The unemployment rate increased for four of the six main demographic groups in August, including young men aged 15 to 24 (+1.2 percentage points, to 11.0%); women aged 55 and older (+0.7 percentage points, to 5.2%); core-aged men (+0.6 percentage points, to 4.6%); and core-aged women (+0.4 percentage points, to 4.5%). It was little changed among young women and older men.

The adjusted unemployment rate—which includes people who wanted a job but did not look for one—rose 0.5 percentage points to 7.3% in August. This increase was largely due to the rise in the number of unemployed rather than an increase in those who were outside the labour force but wanted work.

The hope is that the rising number of unemployed Canadians will help to fill the record job vacancies.

WAGE INFLATION ACCELERATES TO 5.4% IN AUGUST

Particularly troubling for the Bank of Canada is the further acceleration in average hourly wages, which rose 5.4% on a year-over-year basis in August, compared with 5.2% in June and July (not seasonally adjusted).

Bottom Line

The Bank of Canada will welcome the cooling labour market, which will ultimately take the pressure off wage inflation. I don’t expect today’s weaker jobs report to change the Bank’s view that interest rates need to rise further in the coming months to return inflation to its 2% target level.

Bloomberg News reported that despite the rise of mortgage rates heightening “the risk of a correction that could affect asset valuations and repayments” for Canadians, Peter Routledge, the Superintendent of Financial Institutions,  said the Office of the Superintendent of Financial Institutions (OSFI) would not adjust the standards in B-20.

OSFI first created its Residential Mortgage Underwriting Practices and Procedures Guideline (B-20) in 2012. The guideline set expectations for residential mortgage underwriting for federally regulated lenders.

“The uncertainty and anxiety caused by a rising interest rate environment have, understandably, caused some Canadians to advocate for a loosening of the underwriting standards in Guideline B-20,” Routledge said.

“Let me reassure those of you who oppose a loosening of underwriting standards that OSFI will not do that.”

In June, Canada’s banking regulator announced that it tightened underwriting standards on combined loan plans such as reverse mortgages, mortgages with shared equity features and combined loan plans.

Routledge reiterated that OSFI is “constantly evaluating the MQR (Minimum Qualifying Rate) to measure its efficacy in sustaining sound residential mortgage underwriting.”

“Because Guideline B-20 touches home ownership, it gets an extraordinary amount of public attention – at least relative to all our other regulatory guidelines,” Routledge said.

“We accept this reality – housing is crucial to all Canadians, and Guideline B-20, whether we at OSFI like it or not, matters to Canadians. And so, our job is to address concerns with B-20 transparently and forthrightly.”