It’s been just over two years since the Bank of Canada began its aggressive tightening policy in March of 2022. With the Bank of Canada anticipated to soon pivot and start cutting the overnight rate, hopes and signs of an economic rebound are growing. In fact, in its April Monetary Policy Report, the bank lifted its real GDP growth forecast for 2024 to 1.5 per cent, from its prior estimate of 0.8 per cent, supported by a strong January GDP reading
Ahead of next week’s release of the February GDP data, The Globe and Mail spoke with Scotiabank’s chief economist Jean-François Perrault, who discussed his economic growth forecasts, perspectives on monetary policy, as well as key economic growth drivers and risks.
Does the U.S. Federal Reserve need to cut rates this year? When I look at the fundamentals, the economy is resilient, the labour market is strong, and inflation is still above their target.
We think U.S. inflation hovers around these levels this year and then gradually comes down next year, and that’s a little bit different than what we thought a few months ago when it looked like U.S. inflation was on a solid downward path. Now, the last few months it’s been the opposite issue, inflation has surprised on the upside.
As to whether or not the Fed actually does need to cut interest rates, you’ve got to think about monetary policy and the way monetary policy makers think about it, which is it takes a long time for their policies to impact activity. So, while we think the Fed cuts in the second half of this year, that’s really thinking about normalizing policy so that in 2025 and beyond inflation goes to where they need it to.
Our view assumes that U.S. growth doesn’t accelerate going forward and inflation doesn’t accelerate going forward. Now, if those things happen, if you get more surprises on the inflation side, you can easily rule out a rate cut in the U.S. this year and you might have to start thinking about rate increases.
What probability would you assign to rate increases?
Pretty low.
Your U.S. GDP growth forecast for this year is 2.4 per cent. However, in one of your notes you said you wouldn’t be surprised to see growth near 3 per cent.
The pace at which data are coming in and the revisions that we are seeing to the outlook, if we continue on this surprise pace, it doesn’t take that many surprises to bring you up closer to 3 per cent as opposed to 2.25, 2.5.
I think of it in this really simple way. One of the big shocks we have to the U.S., for instance, is retail sales, which are extremely strong and that’s the rate sensitive part of the economy. Household spending is one of the things the Fed would expect to see being weak when they’re having an impact on the economy. We’re seeing the opposite of that - a sharp pickup in retail sales. That suggests that there’s this risk going forward that growth is going to surprise to the upside again.
What’s your 2024 economic outlook for Canada?
We have been revising growth up progressively in Canada, not to the extent that we’re seeing in the U.S. We’ve got 1.5 per cent growth for Canada, in the U.S. you’re well over 2 per cent growth. But, the data are coming in stronger than expected.
On the flip side though, in Canada, is the inflation data have been coming in and surprising to the downside. There is this different inflation dynamic between Canada and the U.S. Canadian inflation is slowing, U.S. inflation is accelerating. So even though growth is being revised up in Canada, it does suggest that there is more likeliness to a rate cut in Canada than in the U.S. at this point or certainly more rate cuts in Canada this year than in the U.S.
You’re anticipating 75 basis points of cuts this year by the Bank of Canada. When do you have the first rate cut occurring?
Our official call is September. We’re starting to waffle between September and July because the inflation data are a little bit better than we thought. To us, it seems unrealistic at this point for the Bank of Canada to cut in June.
I’m sure you speak to many CEO’s of companies. If my assumption is correct, what are you hearing from business leaders regarding capital spending plans, labour plans surrounding hiring and firing, costs, and supply issues. What main themes or insights into economic activity are you hearing from business executives?
We talk to CEO’s and boards pretty regularly in most sectors.
We’re at a point in time when monetary policy hurts the most as it takes 18 to 24 months for monetary policy to have a full impact on the economy. This is around the time, in principle, the economy is the weakest, maybe it was last quarter, maybe this quarter. As a result, it’s normal for businesses to be a little more cautious.
On the labour side, it’s a little bit different. You’re still seeing companies complain about labour shortages, you’re still seeing significant wage gains being offered. You’re still seeing companies hoard workers. It’s unusual in the sense that typically when the central bank raises interest rates, you get a slowdown in economic activity that lowers employment growth, in fact, lowers employment levels and you get some downward pressure on wages. We haven’t really seen that.
But, there is a certain degree of optimism with respect to how the economy responds to lower interest rates because those are coming so that’s impacting how people approach decisions. Once interest rates start to come down, it’s pretty clear that we’re going to get a significant turnaround in the economy and that will carry business investment with it and higher consumer spending, which is in part why we think the government needs to be cautious because if you do that too soon, you create a growth problem, which from a Bank of Canada perspective is an issue, from a business perspective, of course, we all want.
How great of a risk do you see rising commodity prices filtering through the supply chain and lifting inflation?
It’s 100 per cent a risk. The fact that commodity prices are by and large performing well in an environment where monetary policy is still tight around the world, where growth is being suppressed by central banks, where China is in a pretty weak economic situation - that’s the type of environment you would normally see commodity prices being pulled down in. The fact that we haven’t seen it that much really makes you question as the global economy starts to rebound, say in the second part of this year as central banks start to cut rates, what kind of a commodity price response do you get then? For us, this is a really significant issue in terms of inflation control, you’ve got to keep this in mind.
When you consider we may be in an environment of higher for longer interest rates, do investors have to lower or moderate their earnings growth expectations?
I would say no. You’ve got to keep in mind why would interest rates not come down this year and figure out what that means for the economy. Say we end up with 3 per cent growth in the U.S. this year and the Fed doesn’t cut or the Fed has to raise further. Well, that’s occurring because growth is strengthening. That means earnings are probably rising. That means there’s more business to be done. So, if rates are higher for longer because the economy is strong, it’s a different thing than rates are higher for longer for no other reason than central banks are really aggressive in bringing things down.
What about in Canada where rates may be higher for longer, but that’s not because of a strong economy but because the Fed is holding rates steady.
For Canada, it’s a little bit more tricky because you have exactly that going on.
We’ve revised our growth forecast up, but not to the extent that we’re seeing in the U.S. So, it does suggest that there’s a little bit of a differential between how Canadian and U.S. stock markets would adapt to that. But you also got to keep in mind though that if you’re revising your U.S. growth forecast up, you’ve got to revise your Canadian growth forecast up as well, three quarters of exports go to the U.S. So, if we find ourselves with an unbelievably strong U.S. economy, we’re going to have a stronger economy. So, there will be an earnings lift that comes from that in Canada.
Where it gets a little bit tricky though is higher for longer interest rates then impacts multiples because discount rates change. You’ve got the impact of higher interest rates, which depresses stock market valuations to some extent.
There’s been a lot of surprises or turn of events. Not too long ago, we were talking about the risk of a recession. At the beginning of 2023, there were talks about rate cuts but instead, after a pause, there were two rate hikes mid-year. At the start of this year, people were talking about six rate cuts by the Bank of Canada starting potentially as early as March and now those expectations have been scaled back. What do you think may be the next surprise to investors?
We’ll see if it’s a surprise or not, but I think the thing to worry about over the next several months is the result of the U.S. election. We might get some growth surprises between now and then, maybe we get some inflation surprises, which will be meaningful in terms of the timing of monetary policy. The outcome of the U.S. election, for instance, if Trump wins and he does some of the things that he says he’s going to do on the tariff side then you end up in a potentially very different economic space this time next year, or two years from now, or whenever, if he wins and he does the things that he says he wants to do. That will overhang markets for a while until we get clarity on that in November.
In the short run, what we’ve observed and the reason we’ve been scaling back rate cuts in Canada and in the U.S. has largely been because growth has been more resilient than anticipated. If you find yourself in a world where growth isn’t slowing down as much as you thought it was, there’s no recession, then you have to rethink the pace at which you were going to unwind policy because the economy is turning out to be better than you thought, better able to handle those rate increases.
You led me into my next question. Trump has pledged to impose 60 per cent or higher tariffs on goods from China, which would ignite inflation. How do you see this impacting the economy?
It’s broader than that. He’s threatened at least 60 per cent on China and 10 per cent for everybody else so that’s a trade war. That is the Americans declaring a trade war on the rest of the world. Now, would we be included in that or not? I don’t know, it depends on the range of things.
That does two really nasty things. One, it reduces economic activity in the U.S. because you’re paying more for inputs, it’s a supply shock so it reduces growth a little bit or a lot depending on what exactly he does, but also boosts inflation because the cost of goods is rising. So, you have this awful situation where you’re revising your growth forecast down, you’re revising your inflation forecast up and you’re probably raising your rate forecast as well because at the end of the day, central banks have got to manage the inflation side of things. Now, that’s true in the U.S. and it’s also true elsewhere.
What do you see as significant tailwinds and headwinds for the Canadian economy?
Obviously, the commodity sector has been beneficial to us. We’re going to have the Trans Mountain start operating very soon as well so we’re going to benefit from that. There still are relatively strong household and corporate balance sheets in Canada. And then there’s the population dimension, which has been a really powerful tailwind the last couple of years that seems to still be a very powerful tailwind.
On the headwind side, setting aside the election, politics, I think by far the most important is low productivity. It hits our standard of living, it hits our competitiveness, which makes it even more important, say in a Trump tariff world. If we cannot improve productivity in any meaningful way then you have a gradual erosion of competitiveness, a gradual erosion of standard of living, a gradual erosion of well-being in the country and that is a big deal.
Speaking about erosion, I was thinking about housing affordability when you were talking about that. What’s your outlook for home prices?
The market is so undersupplied pretty well across the country. There’s such a large imbalance between supply and demand that it’s very difficult to believe that house prices are going to do anything but rise over the next several years. It’s very difficult to see affordability improving in the next five years.
Will Bitcoin ever be included in your currency analysis?
No. It’s honestly a very difficult thing to analyze. It’s not a currency. There’s no intrinsic value to it. It’s just a financial asset whose value moves up and down on the basis of how many people want to buy and sell it.
Jennifer Dowty