Bank of Canada governor Tiff Macklem received mixed signals about the strength of the economy this week, further complicating an already difficult decision on whether to leave interest rates unchanged or to resume raising them in order to crush inflation.

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Data's mixed messages complicates Bank of Canada's search for 'sweet spot' Back to video

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On May 4, the latest trade numbers suggested consumer demand is weakening, which, in theory, would allow the Bank of Canada to leave interest rates on hold because higher borrowing costs could be starting to bite. Statistics Canada reported that the value of imports dropped 2.9 per cent in March from February, and 5.9 per cent in volume terms.

Desjardins Group economist Randall Bartlett described the decrease as “ominous,” because much of what Canadian households purchase arrives from abroad. “The ongoing weakness in import volumes, particularly in consumer goods and motor vehicles, suggests elevated interest rates may be weighing on household purchases heading into the middle of the year,” he said.

Seeking a ‘sweet spot’

But then, on May 5, Statistics Canada reported that Canadian employers added some 41,000 positions in April, a number that Bank of Montreal chief economist Douglas Porter described as “robust.” The unemployment rate stayed at five per cent for a fifth month, a low level by historical standards that shows Canada’s economy remains in decent shape despite the spike in borrowing costs and a higher cost of living.

“There is no evidence that the labour market is softening at all, lending important support for the broader economy,” Porter said in a note to his clients. “If this persists through the spring, the Bank of Canada may yet be forced to rethink its rate pause, especially with the housing market showing signs of reviving.”

Indeed, data this week showed Toronto home prices rose for a third consecutive month in April, and Toronto home prices rose. The average cost of a home in both cities is more than $1.1 million.

When Macklem started raising interest rates a year ago, he said he would try to achieve a “soft landing.” However, he hasn’t been shy about saying that the Bank of Canada would welcome weaker economic growth. Macklem reiterated during a talk in Toronto that the economy still is in a state of “excess demand,” stoking inflationary pressure because suppliers can’t keep up with orders.

“You do have to be forward looking,” Macklem said when asked for guidance on when he might start cutting interest rates, given mounting evidence that economic growth is slowing and last year’s sharp increase will inevitably hurt mortgage holders. “We’re looking for that sweet spot.”

The consumer price index, which the Bank of Canada uses to guide interest rates, is still increasing at annual rates that are well above the central bank’s target of two per cent. Headline inflation was 4.3 per cent in March, and while policymakers are confident it will slow to three per cent by the summer, Macklem told an audience assembled by the Greater Toronto Board of Trade that he’s worried inflation could then get stuck there.

“We’re really not thinking about interest rate cuts,” Macklem said. “The lesson from history is that cutting prematurely is going to end up being more costly down the road. It is too early to be thinking about interest rate cuts.”

Rough patch

There are other signs that households are retrenching besides weaker imports. National Bank economist Jocelyn Pacquet observed in a note that Statistics Canada’s advance estimate of retail sales in March is for a drop of 1.4 per cent. “Household spending went through a bit of a rough patch at the end of the first quarter,” she said.

Macklem acknowledged in Toronto that the inflation risk has receded considerably since the start of the year, and because interest rate increases slow economic activity with a lag, the effect of last year’s hikes hasn’t been fully felt.

Still, consumption of goods is only one expression of consumer demand. The cost of services remains elevated, and Macklem reiterated that he won’t be satisfied until services inflation slows. Another important variable is wages, which rose 5.2 per cent from April 2022, according to the latest hiring data. That’s faster than inflation and more than the Bank of Canada thinks is sustainable.

“There are some things we need to see happen that we haven’t seen yet,” Macklem said. “If those things don’t fall into place, we are going to have a problem.”

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