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On Wednesday, September 6th at their regular policy meeting, the Bank of Canada (BoC) decided to keep their Policy Rate steady at 5%. This means that most banks will hold their consumer Prime Rate steady at 7.20%, and there will be no changes to the payment amounts for Variable rate mortgage holders.

This was expected by most banks and economists, on the back of Statistics Canada releasing the quarterly gross domestic product (GDP) report on September 1st which showed that the Canadian economy did not grow during the 2nd quarter of 2023 (April – June). In fact, it came in at -0.2%. While this isn’t a recession yet, it is a significant warning sign that the economy is teetering on the brink of a contraction.

This is all the more alarming because Canada’s population has been growing substantially over the same time period through immigration. When new families come to Canada, begin working and buying products and services, all of that activity contributes to our national GDP. In other words, if the positive effects of immigration were removed, our national GDP would definitely be shrinking.

Digging into the numbers, we can see that household spending is softening. New passenger vehicles (-9.5%), furniture (-3.3%), and outdoor recreation (-8.3%) all saw substantial drops in spending. Households are tightening their purse strings and focusing more on just the essentials.

We know that GDP is a lagging indicator – it takes months to gather all the data and compile it. Moreso, it takes months for rate changes made by the BoC to impact businesses and consumers and cause them to change the behaviors that are measured in the GDP. Therefore, the GDP report for Q2 which shows a contraction of -0.2% is mostly showing the results of the BoC rate hikes that happened up to the fall of 2022. All of the further rate hikes that the BoC made over the winter and spring are still working their way through the system, and we expect the next GDP report for Q3 (which will measure July -September activity but won’t be available until late November or early December) will show another significant contraction.

In other words, if you’ve been looking at your bank account and your bills over the last couple of months and things are feeling tight, you are right. We’re likely into a contraction period already, but just don’t have the data compiled yet to confirm it.

Unfortunately, the key mandate of the BoC is to keep inflation low (at 2%) and on that front there are still some headwinds. Oil prices were pushed up in August due to global factors, but the result is that we’re expecting the August headline inflation number to be higher than July. The BoC needs to see inflation coming down slowly over time, and a small increase in July followed by another small increase in August is going to cause the BoC a lot of concern.

The next BoC policy meeting is on October 25th. Between now and then we will have 2 official Consumer Price Index (CPI) reports; the first on Sept 19th, which we expect will show the effects of higher oil prices, and then on Oct 17th just before the next BoC meeting. If the CPI reports do show inflation is in fact continuing to trend slightly upwards despite the economic slowdown, the BoC may be forced to make another 0.25% policy rate increase. This would be a symbolic gesture to try and prevent people from deciding inflation is stuck at a higher level (this is often referred to as ‘entrenched belief’) because once people believe inflation will stay high it becomes a self-fulfilling cycle of higher wage demands causing higher prices causing higher wage demands, etc.

If you haven’t already, I’d encourage you to read our article from last month about the coming wave of fixed rate mortgage renewals over the next 2 years and the impact those will have on the economy. 

Over the next 12-24 months everyone with a variable rate mortgage or line of credit, and everyone renewing their fixed rate mortgages, will be squeezed by higher rates. This will help to ease inflation by reducing household disposable income.  But until finally inflation gets back to 2% and the BoC has room to start cutting the policy rate and providing relief, it’s like treating cancer with chemotherapy – the medicine causes damage and all we can do is try our best to be prepared for the side-effects.

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