Bank of Canada will not be happy with this inflation report

Not only did the headline CPI inflation rate stall at 6.9% last month, but the core CPI numbers remain stubbornly high. Food inflation–a highly visible component–edged down slightly. Still, prices for food purchased from stores (+11.0%) continued to increase faster year over year than the all-items CPI for the eleventh consecutive month. Bonds fell on the news, with Canada’s two-year yield rising to 3.877% at 8:43 a.m. Ottawa time, about 3.5 basis points (bps) higher than its level before the data release. The yield on 5-year Government of Canada bonds spiked temporarily on the release of these disappointing inflation data. This was in direct contrast to the US, which posted a better-than-expected inflation reading for October last week.

Less than two weeks after a stronger-than-expected jobs report, the inflation numbers continue to show the economy in overheated territory. Bank of Canada Governor Tiff Macklem has said that rates will need to continue to rise further while acknowledging the end of this tightening cycle is near.

Traders are pricing at least a 25 basis-point increase at the next policy decision on Dec. 7, with a 50-50 chance of a half percentage point hike. The central bank has increased borrowing costs by 3.5 percentage points since March, bringing the benchmark overnight lending rate to 3.75%.

A significant factor in the Bank’s decision process is the continued rise in wage inflation to a 5.6% annual pace in October. If inflation expectations remain robust, wage-price spiralling becomes a real threat.

Bottom Line

Price pressures might have peaked, but today’s data release will not be welcome news for the Bank of Canada. There is no evidence that core inflation is moderating despite the housing and consumer spending slowdown. The average of the Bank’s favourite measure of core inflation remains stuck at 5.3%. The central bank slowed reduced its rate hike at the October 26th meeting to 50 bps, and while some traders are betting the hike in December will be 25 bps, there is at least an even chance that the Governing Council will opt for an overnight policy target of 4.25%.

Inflation is still way above the Bank’s 2%-target level. Ultimately, it will take a higher peak interest rate to break the back of inflation. I expect the policy target to peak at about 4.5% in early 2023 and to remain at that level for an extended period despite triggering a mild recession in early 2023.

Very strong employment report for October 

Today’s Labour Force Survey for October was surprisingly strong, boosting wage inflation to an eye-popping 5.6% year-over-year pace. While good news for the economy, this is terrible news for the inflation fight–just when the Bank of Canada eased its foot on the brakes. The two-year and five-year Government of Canada bond yields spiked on the news, calling into question the Bank of Canada’s decision last week to trim the rate hike to 50 bps rather than the 75 bps that was expected. While one month’s data is not enough to draw too fine a point, this does call into question the assumption that fourth-quarter growth will be substantially less than 1%.

Following four months of declines or little change, employment rose by 108,000 (+0.6%) in October. This increase—widespread across industries, including manufacturing, construction, and accommodation and food services—brought employment back to a level on par with the most recent peak observed in May 2022. All of the gain in October was in full-time work, another indicator of economic strength. This was the first gain among private sector employees since March when the Bank of Canada began hiking interest rates.

After declining in September, the unemployment rate remained at 5.2% in October, 0.3 percentage points above the record low of 4.9% observed in June and July. The adjusted unemployment rate—which includes people who wanted a job but did not look for one—was virtually unchanged in October at 7.1%.

In October, the labour force—or the total number of people who are either employed or unemployed—was 110,000 (+0.5%) more significant than in September. The labour force participation rate rose 0.2 percentage points to 64.9% in October but fell 0.5 percentage points short of the recent high of 65.4% in February and March 2022.

Employment rebounded in construction and manufacturing. The number of people working in construction rose by 25,000 (+1.6%) in October, with increases in five provinces, including Quebec (+17,000; +5.9%) and British Columbia (+6,000; +2.5%). Despite this increase, employment in construction was virtually unchanged in October compared with March 2022, consistent with the latest data on gross domestic product showing slowing economic activity in the industry over a similar period.

Employment rose by 24,000 (+1.4%) in manufacturing, mainly offsetting the decrease of 28,000 (-1.6%) recorded in September. Most of the increase was attributable to British Columbia (+12,000; +6.9%) and Nova Scotia (+3,700; +11.6%). On a year-over-year basis, employment in manufacturing was little changed.

The number of people working in accommodation and food services increased by 18,000 (+1.7%) in October, the first increase in the industry since May. According to the latest data from the Job Vacancy and Wage Survey, the industry had a higher job vacancy rate than all other industries in August.

Employment in professional, scientific and technical services rose by 18,000 in October (+1.0%), the third increase in six months. The number of people working in the industry has followed a long-term upward trend since June 2020, and in October was 297,000 (+19.3%) above its pre-pandemic level.

In October, the number of people working in wholesale and retail trade declined by 20,000 (-0.7%). Employment in the industry last increased in May and was little changed on a year-over-year basis in October. According to the latest data on retail trade, while retail sales increased 0.7% to $61.8 billion in August, advance estimates suggest that sales decreased 0.5% in September.

Of paramount importance to the Bank of Canada’s endeavours to wrestle inflation to a 2% pace, average hourly wages last month were 5.6% higher than one year earlier, accelerating from a rate of 5.2% in September. Despite average wages growing by more than 5% on a year-over-year basis in each of the past five months, they have not kept pace with inflation, which was 6.9% in September, contributing to concerns about affordability and the cost of living for many Canadians.

In separate news, the US employment data for October were also released today, showing stronger-than-expected hiring and wage gains, while the jobless rate ticked up a bit more than expected.

Bottom Line

Today’s labour force data in Canada throws into question the widespread assumption that the Bank of Canada can ease off the brakes very soon. I believe Governor Tiff Macklem will hike rates by another 50 bps in December and continue with 25 bp increases early next year. Today’s employment report raised the odds of the peak in the policy target of 4.5%.