The Bank of Canada could start cutting interest rates before inflation reaches its two per cent target, but only if the labour market co-operates, economists at Desjardins Group say.
A balancing in the labour market that brings the unemployment rate to 6.5 per cent combined with an inflation rate at or below three per cent is likely the magic formula that prompts a Bank of Canada interest rate cut, Desjardins economists Royce Mendes and Tiago Figueiredo said in a note on Nov. 20.
If the economy stays on its current path, that move to cut rates could happen as soon as the second quarter of 2024. The Bank of Canada’s key policy rate is sitting at five per cent, the highest level in 22 years.
Mendes and Figueiredo said policymakers are closely watching the labour market for signs of rebalancing, and eyeing in particular the vacancy-to-unemployed ratio — a measure of job openings versus unemployed people — for clues as to when that will happen. Vacancies have been falling just as the number of people without jobs rises, bringing the current ratio to just above 0.5, a level last seen before the pandemic. That ratio is expected to fall to 0.5 early next year if job openings keep declining and unemployment continues to rise. At that point, unemployment will be at about six per cent, the economists said.
But that still won’t be enough to prompt a rate cut, with bankers wanting to “err on the side of caution so they don’t ease prematurely,” Mendes and Figueiredo said. That means the bank will want to wait until the vacancy-to-unemployed ratio hits 0.4, which would amount to a 6.5 per cent unemployment rate. Wage pressures will also be weaker at that point, they said.
Of course, the inflation rate also plays a critical role in the
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