It’s time for the Bank of Canada to stop being scared of its own shadow. The central bank made a mistake in one direction (as did most central banks) when it was late on the inflation surge, and now risks making a different mistake in the other direction.

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David Rosenberg: Memo to Tiff Macklem — don’t make another mistake in the other direction Back to video

At the March 6 policy meeting, the press statement concluded that “… the data point to an economy in modest excess supply.” Yet, it is pursuing a policy that would otherwise be more appropriate for an economy in an excess demand backdrop. This is no time for hubris.

Inflation rate headed south

The latest inflation data tell the tale. The core ex-food and energy consumer price index (CPI) rose by less than 0.1 per cent month over month in February for the second month in a row; and this hasn’t happened in three years. The year-over-year trend is now below three per cent (within the target range) for the first time since July 2021, the six-month annualized trend is down to 2.3 per cent, and the three-month trajectory is at 1.4 per cent — underscoring the extent of the disinflation momentum.

The CPI-median measure of core inflation has also come in south of 0.1 per cent month over month for the second month running, highlighting the fact that this disinflation theme has moved from a narrow base and is starting to broaden out. Quite frankly, we have not seen successive prints this benign since the spring of 2012, when the economy was still healing from the global financial crisis.

The real key in the recently released CPI report was the -0.1 per cent month-over-month reading in the CPIX, which excludes the eight most volatile price components as well as indirect taxes. This comes after two flattish months and provides the first whiff of deflation since July 2020. The trend in CPI ex-mortgage interest costs was running at 4.7 per cent year over year a year ago and has since melted to 1.9 per cent. This is below the pre-COVID-19 pace of 2.3 per cent.

Not just that, but if you strip out mortgage interest, which is a statistical source of inflation in the CPI that is actually caused by the Bank of Canada, the CPI has essentially shown no net change from August to February. That’s a six-month beavertail in prices if you exclude the monthly mortgage payment to the bank. That hasn’t happened since August 2020, when COVID-19 was raging, and the economy was in lockdown mode.

The ex-shelter index (which also takes out the rental component) has gone from 4.9 per cent year over year a year back to 1.3 per cent now, or about half of where it was pre-pandemic. Yes, pre-pandemic underlying inflation rates, when the pre-pandemic policy rate was 1.75 per cent, not five per cent.

This is the most punitive real rate since March 2008 (gulp)

This brings me to where real interest rates reside: the real Bank of Canada policy rate (adjusted for core inflation) has soared from -40 basis points a year ago to 210 basis points today. The long-run mean is around 85 basis points. Just by this assessment alone, the central bank is some 130 basis points too tight. Yet, Macklem and crew have been spending months trying to talk the markets into pricing in rate cuts half that amount. At what point do these folks stop living in the past?

No need to wait for Fed

This is the most punitive real rate since March 2008 (gulp) and is at the same level we experienced in July 2001 (gulp again). With the benefit of hindsight, we know the Bank of Canada was late to the game when the time came to shift towards a more accommodative stance, but why deliberately throw the economy into an unnecessary recession?

Back to that March 6 press statement: “The bank continues to expect inflation to remain close to three per cent during the first half of this year before gradually easing.” Well, the headline inflation rate was 2.9 per cent year over year in January and 2.8 per cent in February. The core inflation rate went from 3.1 per cent to 2.8 per cent (it was 3.5 per cent in November). So, things are starting to unfold just a little quicker than the central bank had been expecting. Then why wait until the summer to cut rates, when the next meeting is less than a month away?

Some may say the Bank of Canada can’t possibly move out of lockstep with the United States Federal Reserve. Rubbish. It has done so in both directions several times in the past.

The unemployment rate in the U.S. is up from the cycle low, but not to the same extent as has been the case in Canada where it has jumped a full percentage point to 5.8 per cent. The pre-pandemic unemployment rate was 5.5 per cent. It is now 5.8 per cent.

The current ex-mortgage interest inflation rate is at 1.9 per cent, and just before COVID-19 hit, it stood at 2.3 per cent. The overnight rate was 1.75 per cent then and is five per cent now. What exactly am I missing? Or perhaps, what is it that the Bank of Canada doesn’t seem to get?

Not to mention that real gross domestic product (GDP) growth in the U.S. over the past year is 3.1 per cent, whereas in Canada, even with an immigration-led population boom of epic proportions, it is at a paltry 0.9 per cent. Believe me, once (if?) the U.S. begins to see the sort of economic performance that Canada is turning in, the Fed will be singing like a canary as it scrambles to cut rates.

Wage growth not a worry

Concerned about wages? Don’t be. The Bank of Canada’s “common wage” indicator, at three per cent year over year, has decelerated from 3.3 per cent a year ago. It’s light years away from the 5.3 per cent cycle peak and back below where it was pre-COVID-19 when the trend was at 3.3 per cent.

Do you think the 186,000 Canadians who became unemployed these past 12 months (a huge 17.3 per cent increase) are really going to be bargaining hard for a bigger pay packet? The number of folks who have entered the labour market looking for work has exceeded the number who have managed to find a job by 50 per cent over the past year. Is there a construct in practice or theory that takes you to a conclusion of wage inflation ahead? Consider that a rhetorical question.

South of the border, Fed chair Jay Powell turned his focus towards an inflation subindex that measured service sector prices net of energy and the rental metrics (the so-called Powell “super-core”). He only did this because this particular index provides a read of labour market tightness in the services sector — the sector that boomed once the economy reopened and enjoyed the fruits of all the prior fiscal stimulus.

That’s also when the labour market demand-supply background was so out of kilter. As of February, this measure of core services inflation state-side was 4.3 per cent. In Canada, try one per cent — it was at 4.2 per cent this time last year. This index was almost flat in February sequentially after having declined in each of the prior two months.

Already late?

The more we dig into the data, the more we wonder whether the Bank of Canada should have already begun the process of unwinding the damage already done these past two years. At this stage, the initial rounds of cuts won’t even be a policy easing so much as taking the thumb off the economy’s Adam’s apple.

There may be some concern that rate cuts by the central bank will spur the housing market back into an inflationary impulse. But the opposite may well happen if the rate relief incentivizes the construction sector to build more homes and rental units. What is more important for a real estate developer than interest rates? So, it is possible, if not plausible, that the supply response more than offsets the demand stimulus over the medium term.

At the same time, the Bank of Canada has to carry out policy for the economy as a whole and not be sector centric. It must take a holistic view. Consumers make up close to 60 per cent of GDP and their net-worth-to-income and debt-to-asset ratios are off the recent peaks. Total household debt growth has evaporated in volume terms, which is practically without precedent, and personal savings rates rose in 2023. This is symbolic of a hunkering-down mentality and a move afoot to shore up balance sheets, and this is disinflationary in every meaning of the word.

Weaker loonie

There is also an argument that the Bank of Canada easing ahead of the Fed would lead to a weaker Canadian dollar and reflate goods price inflation. Well, the thing is, Canada has become so cost uncompetitive that with no pro-growth supply-side measures on the fiscal (or regulatory) side to reverse years of declining productivity, the economy is in desperate need of a softer loonie as a crutch. And there is so much deflation in the goods-producing pipeline that a resurrection of goods sector inflation stemming from currency depreciation is out of the question.

I mentioned disinflation as it pertains to the CPI, but the operative word is deflation when it comes to the producer price index (PPI), which leads the product side of the CPI index. And producer prices in Canada have deflated 1.7 per cent on a year-over-year basis as of February and are 6.8 per cent below the May 2022 peak. This pace was around one per cent just before COVID-19. PPI ex-energy is running at a -1.1 per cent year-over-year pace (it was one per cent a year ago), so the level is actually below where it was in March 2022 when the Bank of Canada began its tightening crusade (and yet again, compared to a flat pre-pandemic trend).

The Bank of Canada would be well advised not to make another mistake in a different direction, unless creating the conditions for a destabilizing recession has suddenly become part of its mandate.

David Rosenberg is founder and president of independent research firm Rosenberg Research & Associates Inc. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.