BDC Monthly Economic Letter July 2024

Policy rate likely to remain at 4.75% this summer

The Bank of Canada lowered its key rate by 25 basis points at its June meeting, but is unlikely to do so again on July 24. Inflation has risen slightly since the central bank’s last announcement, while the economy continues to show resilience.

Although the labour market is showing signs of easing, wage growth is still a problem, with the year-on-year change in average hourly earnings rising to 5.4% in June. This pace is far too high to match the 2% inflation target. The key rate is now expected to remain at 4.75% this summer, meaning that the Board of Governors will take a break in July to see how the economy is evolving ever since the June cut. The next rate cut could be announced as early as September if inflation turns around.

The loonie rebounds from June’s decline

The Canadian dollar has appreciated slightly since the beginning of July. In June, the loonie traded at 72.6 US cents, but closed the month higher (above US$0.73).

The Canadian currency’s recent, albeit slight, improvement against the US greenback is unlikely to continue for much longer nor gain significant strength. The Canadian dollar is expected to remain between US$0.72 and US$0.74.

Business confidence stable

In June, the CFIB business confidence index for the coming year remained unchanged. The index stayed above the fateful 50 threshold, reaching 56.3. Businesses remain on their toes in the shorter term, as the three-month index recorded a marginal decline of 0.9 points.

An indicator of 50 means that as many company managers expect the business environment to deteriorate as to improve over the period covered (either 12, or three months).

Canada’s economy slows but remains in positive territory

After a decent performance in March, many sectors of the Canadian economy picked up in April. Monthly growth of 0.3% was fairly widespread, with 15 of the 20 sectors covered by Statistics Canada reporting gains.

Preliminary estimates suggest that growth continued in May at a rate of 0.1% compared with April.

A slowing construction sector hurts Q2 growth

A nascent recovery in the construction sector turned out to be short-lived. After a strong March—during which construction reached its highest rate in 18 months—activity slowed again in April.

The downturn was felt mostly in residential construction, a sector where the country is in dire need of growth to address its housing challenges. Activity in the sector is still 24% below the peak reached in April 2021. The industry was expected to recover somewhat in May, with housing starts up 10% over April.

Residential construction has faced its share of issues in recent years. Rising material costs and higher interest rates have hurt the profitability of projects despite the growing need for housing across Canada.

The most recent interest rate cut, and subsequent ones expected in the coming year, should bring some respite to the industry. However, labour issues will continue to impact the sector, whose productivity has been declining for some years now.

Household finances continue to improve

With the Bank of Canada’s final interest rate hike a year ago now, households seem to have adapted their budgets to a higher rate environment. This is evidenced by the household debt service ratio. This ratio measures the share of disposable income needed to pay current and future debts. It has fallen modestly in 2024, standing at 14.9% in the first quarter.

This means that, even without any change in the Bank of Canada’s monetary policy, a smaller proportion of household disposable income is being devoted to debt servicing. Thus, a larger share can be allocated to other spending in the economy. The decline remains small but is nevertheless encouraging because the data dates from before the recent interest rate cut.

Household debt as a proportion of disposable income has also fallen steadily over the past year. For every dollar of disposable income, Canadian households owed $1.83 at the start of 2023, compared with $1.76 recently.

First rate cut should stimulate growth

Consumer spending is the engine of economic growth in Canada, accounting for around 60% of GDP. The Bank of Canada lowered its key rate by 25 basis points in early June and the market expects further cuts in the second half of 2024.

However, we believe that the Board of Governors will be cautious, evaluating the impact of the first cut before announcing further reductions. Although still small, the first cut should nonetheless support growth in the months ahead.

According to the Nanos-Bloomberg survey, consumer confidence has improved markedly since the rate cut. While confidence is still low by historical standards, it’s currently at a two-year high and should encourage greater spending by Canadians.

A rising real estate market is also likely to help dispel pessimism across the country. Although the increase was not reflected in all markets, the average selling price of homes on the resale market exceeded $700,000 in March for the first time since June 2023.

The labour market remains solid but easing continues

Employment remained steady between May and June. With more than 340,000 jobs created in the 12 months to June the labour market remain on solid footing. The unemployment rate increased slightly again in June at 6.4%, 0.2 points above May’s reading.

While job growth is certainly supporting consumer confidence, declining vacancies and a stable unemployment rate signal that the labour market is softening. Nevertheless, strong wage growth continues.

In June, national wage growth was 5,4% higher than the previous year. Pay in service industries is growing faster than goods-producing industries. This indicates that the pace of wage increases continues to pose a risk of rekindling inflation.

The impact on your business?

• Interest rates are set to come down again in the second half of the year, but the Bank of Canada will be cautious and assess the impact of the first cut on the economy before announcing a new one.
• Consumers are regaining confidence in the economy, which should be reflected in their spending. Retailers will feel positive effects, but rates are still high. Wherever possible, differentiate your products to attract the most budget-conscious consumers.
• A further slowdown in residential construction in April, coupled with rising prices on the resale market, risk fuelling more housing inflation. The construction situation is likely to improve as the Bank of Canada lowers rates but could have the opposite effect on the resale market.