Yahoo Finance Labour market key for Bank of Canada interest rate decisions: CIBC
Economy shed a net 6,400 jobs in July; unemployment rate up for third straight month
As the Bank of Canada continues to try and wrestle inflation to its 2 per cent target, CIBC economists say that labour market indicators will be the key factor in terms of when the central bank decides to halt its tightening cycle and even potentially lower rates.
In an analysis of the Bank of Canada's inflation outlook released on Tuesday, CIBC chief economist Avery Shenfeld and senior economist Ali Jaffery wrote that labour market indicators have replaced real GDP as the key guide to forecasting the central bank's rate decisions.
"For decades, the Bank largely ascribed accelerations or decelerations in trend inflation to whether real GDP would run above or below its estimate for Canada's non-inflationary potential: the so-called 'output gap'," the economists wrote.
"While its Monetary Policy Report still speaks in such terms, the reality is that the output gap hasn't been a useful tool, or a guide to forecasting Bank of Canada rate decisions, since the fall of 2021."
The economists wrote that measuring the output gap has always been challenging, but it became particularly difficult in 2021 when real GDP was still below pre-pandemic levels but labour markets were tight.
"It made no sense to claim that the economy had so much near-term headroom for non-inflationary output gains with so few workers left to add to the mix," they wrote.
"All of this has meant that the starting point for the output gap, and subsequent growth rates, no longer gave stable guidance on whether the economy was overheating and likely to push inflation up or down. An inflation-targeting central bank, and financial market participants, needed a new signpost to follow."
That signpost had been labour market indicators, including unemployment, job vacancy rates and wage growth, that could show whether the job market was in excess demand or supply.
The most recent jobs report released earlier this month showed that the economy unexpectedly shed a net 6,400 jobs in July, and the unemployment rate ticked higher for the third consecutive month. The print bolstered expectations that the Bank of Canada will likely remain on the sidelines for its next interest rate decision and put its tightening cycle on pause.
The CIBC economists wrote in their report that if the unemployment rate is above 6 per cent by early 2024, what that means for the Bank of Canada will depend on what factors weigh on the outlook for growth and employment.
"Our point here is that labour market indicators, not the ever-vacillating measure of the output gap, will and ought to be the key to whatever choice it makes."
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.
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