End To Rate Cuts Soon Unlikely

As inflation progresses on a path to central bank targets, fixed income investors expect inflation-fighting central banks to ease off on the aggressive rate-hiking cycle and possibly even consider cutting interest rates later in 2023, depending on the severity of any economic slowdown, says Beutel Goodman’s fixed income team. However, its view is expectations for rate cuts anytime soon are overly optimistic as it is likely too early for central banks to declare victory in the battle against persistently high inflation. All Items CPI (year over year) in Canada peaked at 8.1 per cent in June 2022 before declining to 6.3 per cent in December. On the journey back down towards the Bank of Canada’s (BoC) inflation target of two per cent, it says there will be some easy wins before a bit of a tougher slog. One of those easy wins is the continued easing of commodity prices, which surged following Russia’s invasion of Ukraine on February 24, 2022. By March, for example, the price of West Texas Intermediate crude oil had breached US$120/barrel, but prices have since fallen to below US$80/barrel. This decline is also being reflected at the pumps, where gasoline fell by 13.1 per cent between November and December 2022 – the largest monthly decline since April 2020. However, it is unlikely that all components of inflation will fall as quickly. The Sticky Price CPI (consumer price index) incorporates expectations about future inflation. Given that sticky prices make up the bulk of CPI and are most directly tied to wages and a strong labour market, it is with these components – which includes most services – that the BoC faces its greatest challenge. It is unlikely inflation will decline all the way back down to targets during 2023 as sticky inflation will become harder to reduce. The decline from eight per cent to four per cent should be the easy part of disinflation, as supply-side inflation pressures abate. It is the next leg down in inflation that is more difficult and will require demand destruction and will likely come in the form of a higher unemployment rate.