In this week’s The Seven…

• Goldilocks? U.S. inflation falls despite solid growth
• Next week: All eyes on Canadian inflation data
• Why care? Canada’s declining GDP per capita
• Trains and planes - more disruption risks
• More to build - Construction intentions up in Alberta
• Interesting Fact: The Carbon Capture Conference in Edmonton
• Charts of the Week: Chasing affordability - housing costs rise most in less expensive markets

Fall is in the air, but the (inflation) doves won’t be migrating anytime soon. The Bank is poised for further rate cuts—we expect two more this year and four next.  But even after the Bank wrestles inflation back to its target, some longer-term issues remain. We talk about the latest on Canada’s struggling GDP per capita and productivity, and ask—why care?

In our Charts of the Week, we show that some of Canada’s least expensive markets are seeing the largest price and rent increases. It’s a version of the ‘chasing affordability’ theme we have long argued is driving migration flows and housing patterns across the country.

Turning the page - U.S. inflation lowest in three years

Can the U.S. pull it off? A return to 2% inflation without a major slowdown, let alone a recession. The latest inflation and economic data have been reassuring.

August consumer prices rose 2.5% from a year ago, the lowest level in three years and matching Canada’s reading in July.* There are cracks showing in the labour market, but all things considered, the economy has held up exceptionally well with a 4.2% unemployment rate in August. Real GDP growth clocked in at 3% last quarter, and is tracking in the mid 2s for Q3 (as of the September 9th Atlanta Fed nowcast).

If there was any doubt, this report virtually guarantees that the Federal Reserve will join the rate cutting party next week—the last meeting before the election. A cut is fully priced in by the market. The only question is will they go big with a 50-basis point cut.  Fed Chairman Jerome Powell said at Jackson Hole “the time has come for policy to adjust,” and will not let an election stand in the way. According to Reuters, assuming the Fed cuts next week, this would be the second closest pre-election policy change since at least 1976.

*A caveat - CPI measures between Canada and U.S. are not directly comparable, with particularly large differences in how shelter costs are measured.

This Tuesday: Canadian inflation data

Will Canada’s inflation rate fall further in August? We think so. Gasoline prices fell last month and mortgage interest costs will continue to add less to the inflation tally. In July, inflation came in at 2.5%, the lowest since March 2021.

Tiff Macklem and company will mull over one of two more inflation readings before the October 23rd rate announcement. Their main focus is on the trend. And lately, that trend has been their rate-cutting friend. Core readings have been easing for the last year, and price growth excluding shelter costs has been falling (CPI excluding mortgage interest costs was at only 1.8% y/y in July, and CPI excluding shelter costs was 1.2%).

Here’s our timeline of the Bank of Canada’s thinking (at least how we see it):  In the Spring 2024, the Bank saw inflation easing, but needed to see it longer. In the Summer, the Bank saw it long enough to cut. Now heading into the fall, the Bank is more concerned about growth and has become more clear they will keep cutting as long as inflation cooperates.

One early concern was that the Federal Reserve would be on hold longer, causing major rate divergence - pushing down the loonie, and putting upward pressure on inflation. But with the Fed looking to cut, those concerns have subsided (indeed the 2-year bond yield spread between the countries has tightened since June).

A risk, flagged by Governor Macklem in a speech this week, is the potential for ongoing trade disruptions to push inflation higher.

Our view is that inflationary pressures will continue to ease, paving the way for the Bank to keep cutting. A softening labour market will ease wage pressures, apartment/condo rents are falling in some hot markets (see our Chart of the Week), mortgage interest costs will add less punch, and sticky service costs will relax with the labour market.

For us, it’s a question of 25 or 50 basis point cuts in October. Very friendly inflation readings and a disappointing September jobs report (coming October 11) could easily push our call into the 50-point camp. For now, we stay at 25.

Canadian living standards  - Another measure looks less grim, but there’s a catch

Canada’s languishing productivity and related drop in GDP per capita, have been discussed in several recent reports, including here (our summer project was a report on productivity).

Now a couple more reports to add to the mix.

First, new data released last week showed Canadian business sector labour productivity fell at an annualized rate of 0.7% in Q2 2024—the eighth quarterly decline in the last nine quarters. While Canada’s labour productivity is expected to finally start improving, it just hasn’t happened yet.

Second, Trevor Tombe from the University of Calgary recently showed that Canada’s GDP per capita may slip below the OECD average this year for the first time since at least 1970. So it’s not just a Canada-U.S. story. Within North America, Alberta places first among the Canadian provinces, but its ranking among provinces and U.S. states has slipped to 17.

Should we even care about declining real GDP per capita? Afterall, it’s not the only measure of economic well-being.

A comprehensive new paper by Phillip Smith (former Assistant Chief Statistician with Statistics Canada) discusses an alternative (but related) measure to GDP per capita: Household Disposable Income (HDI). The good news is that Canada fares much better according to this measure (it continues to increase). The challenge is that real GDP per capita declines can only be sustained so long before it hurts HDI. As Smith summarizes:

“Canadians are fortunate that their real disposable incomes, on average, have not declined despite the pandemic in 2020-2021 and the slower pace of economic growth in recent quarters. But the falling trends in real GDI and GDP per capita over the last two years do not augur well for the future.”

More to build - Construction intentions up in Alberta

Alberta’s home construction sector is on a roll. As we reported yesterday, the inflation-adjusted value of building permits was up 33% over the first seven months of the year compared to the same period in 2023, following a similar trend in housing starts. It’s a positive sign, as builders try to keep up to the booming population.

Among all the variables we forecast, two have surprised us the most—population and housing. In June, we expected them both to be strong. But we underestimated the resiliency of both migration inflows and the ability of builders to respond to that demand.

I continue to hear from industry that construction labour shortages are an issue (this is supported by elevated job vacancy rates), and we do see that as a limiting factor.

Trains and planes - a potential airline strike in Canada

First it was a rail strike, and now there is looming risk of Canada’s largest airline taking job action.

Our ATB Capital Markets team has been following this situation closely. According to Chris Murray, Managing Director of Institutional Research, a strike would impact 80% of Air Canada’s domestic flights and severely impact international travel, with daily operating revenue losses to the company of about $10M.

The last time Air Canada went on strike in 1998 there was a noticeable short-term hit on GDP in the airline industry—a 15% drop in September 1998 followed by a 22% bounce back the following month. As we discussed during the rail strike, duration is key with impacts compounding with time due to broader supply chain impacts.   The impact is much broader than the hit to airline GDP, with tourism and industries that rely on airline freight also suffering.