Many Canadians breathed a sigh of relief when the Bank of Canada signalled at its last interest rate meeting on Jan. 25 that it would likely pause further hikes to assess whether it had done enough to quell inflation.
So far, the bank has raised rates 425 basis points — a historic run in speed and trajectory — to 4.5 per cent from 0.25 per cent in March 2022. It has said it needed to do so to get a handle on inflation, which peaked at 8.1 per cent in June 2022, well outside the bank’s target range of one to three per cent. Inflation currently sits at 6.3 per cent.
But that leaves us wondering what data the bank will be tracking to confirm it can hold off on further hikes. Avery Shenfeld, chief economist at CIBC Capital Markets, in a recent analysis said it won’t be the usual suspect, the output gap, a measure of how much the economy is producing against how much it can produce. Instead, he believes the Bank of Canada will keep its eye fixed on labour data.
“It’s apparent that rather than look at economic output, the bank is focused on tightness in one key input: labour,” he said, adding that the unemployment rate, the number of job vacancies and total hours worked will likely be the best predictors. “For our part, we’re looking for enough signs of slack in these measures to keep that pause in place, but not a rapid enough turn of events to allow an easing in rates until 2024.”
Shenfeld said roof of the Bank of Canada’s focus can be found in its most recent Monetary Policy Report (MPR), in which the bank mentioned labour markets first “as the indicator that the economy is in excess demand.”
Canada’s labour market has put up some pretty stunning numbers during the past few years, which has only fuelled inflation and forced the central bank to end its cheap-money policies.
Right now, it’s hard to find slack in jobs measures, but economists believe signs are beginning to materialize.
The unemployment rate currently stands at five per cent, just above its historic low of 4.9 per cent in July 2022. Canada’s economy is considered to be in full employment, meaning all those who wish to work can find a job. A higher unemployment rate would signal some give in the labour market. The 10-year average for the jobless rate is 6.8 per cent.
Historically high job vacancies have plagued the labour market for a while, creating tight hiring conditions for employers. There were 823,484 open positions in Canada as of November 2022, Statistics Canada reported, still elevated, but a significant drop from the record 1,035,755 openings reported last May.
“While businesses are still struggling to find staff, the drop in job openings is an early indicator that the overheated labour market may be about to cool,” wrote Helene Begin, principal economist at Desjardins Economics, in a weekly commentary released on Jan. 27.
Total hours worked, another one of the measures Shenfeld is watching, rebounded after plummeting during the depths of the pandemic. They currently sit above levels recorded prior to 2020, although the number of hours worked “has stopped growing,” wrote Desjardins’ Begin, and have “even begun to fall in some provinces, including Quebec.”
“Hours worked aren’t a foolproof indicator, but they tend to show where employment is headed,” Begin said.
National Bank of Canada economists are on the same page when it comes to the role of the jobs market in determining what happens next with rates.
“Of course, inflation data will still be the key determinant in future decisions” — something Shenfeld doesn’t agree with — “but the bank is also surely hoping to see some slack open up in the labour market in the coming months too,” said economists Taylor Schleich, Jocelyn Paquet and Warren Lovely in a note following the Jan. 25 rate increase.
“The next few months will be crucial to cooling off the overheated labour market,” Begin said.