Why the Bank of Canada Will Be Cautious in 2018 (And It Isn’t Just Because of the January Employment Data)

After thirteen straight months of impressive gains, Canada’s labour market hit the brakes hard last month.

Our economy lost 88,000 jobs in January and that marked our biggest one-month drop in nine years.

Investors reacted quickly, driving Government of Canada (GoC) bond yields lower on Friday and decreasing the odds of a Bank of Canada (BoC) rate hike in April from 58% to 50% (which is still way too high in my opinion, but more about that later).

The BoC has said that it will be heavily data dependent when determining its future monetary-policy path. If the latest employment report is an early signal that our surging employment momentum is now abating, this means that the Bank will delay additional rate rises.

As always, however, the market shoots first and asks questions later. It is worth remembering that Statistics Canada’s employment data are estimates that come with significant margins of error (to both the upside and downside). Bluntly put, the latest employment data, bad as they seemed, were not a game changer and the BoC isn’t going to blow up its existing plans over one lousy jobs report.

Here are the highlights, or in this case, the lowlights, from the January employment data:

• The Canadian economy lost an estimated 88,000 jobs in January compared to the consensus forecast that it would add 10,000 new jobs during the month. To make things worse, the initial headline estimate for December was also revised down from +78,600 to +64,800.
• The private sector lost 71,000 jobs, the public sector lost 41,000 jobs, and self-employment rose by 23,900. A spike in the self-employed ranks is not generally considered a positive signal because it often masks additional job losses, for example, when people prefer to categorize themselves as ‘newly self-employed’ rather than as ‘out of work’.
• Our economy actually added 49,000 full-time jobs last month, but that was offset by the loss of 137,000 part-time jobs. Of those, 51,000 part-time jobs were lost in Ontario and some market watchers attributed that dip to Ontario’s decision to hike its minimum wage from $11.60 to $14 on January 1. The detail in the data cast some doubt on that view, however, because the sectors that were most impacted by the wage hike did not account for many of the part-time jobs lost last month.
• Our unemployment rate rose from 5.8% to 5.9%. The silver lining in that result it that, at the macro level, this additional unused labour capacity should help extend our runway of non-inflationary growth (which BoC Governor calls our “Inflationary Sweet Spot”).
• Our participation rate, which measures the percentage of working-age Canadians who are either employed or actively looking for work, fell from 65.8% to 65.5%. That result will confound our policymakers because disenfranchised workers are expected to rejoin the labour force when conditions are improving. This result has fueled speculation that the view from ground level isn’t as rosy as the recent data appeared to indicate.
• Average wages rose 3.3% on a year-over-year basis. While that result was above trend, it was attributed in part to recent minimum wage hikes in Alberta (October, 2017) and Ontario (January, 2018).

There is no denying that the January employment data threw cold water on our previously red-hot employment momentum but I think the market over-reacted to the news, and I don’t expect the BoC to do the same.

That said, I continue to believe that the BoC is going to be much more cautious with additional rate rises than the consensus believes – but primarily for these reasons:

• BoC Governor Poloz estimated that it can take anywhere from one to two years for policy-rate increases to fully work their way into our economy. We have now had three in the past eight months and I think the Bank wants to allow time for them to realize their full impact.
• The sixth round of mortgage-rule changes was just implemented on January 1, 2018. Here again, I expect the BoC to “remain cautious” as it assesses the impact of these macro-prudential changes.
• Our inflation gauges have been trending up of late, but the BoC largely foresaw this. In its latest policy statement, made on January 17, the Bank predicted that “temporary factors” would cause inflation “to fluctuate over the near term” but still forecast that inflation would “remain close to 2% over the projected horizon”. This is right in the middle of their target range and in that context, I don’t think the Bank is overly concerned about our recent inflationary uptick.
• Our policy makers still face great uncertainty about the future of NAFTA and trade with the U.S. President Trump has said that he may wait until after Mexico’s presidential election in July before deciding NAFTA’s fate. The BoC doesn’t want to lean too far out over its ski tips while this economic sword of Damocles still hangs over our heads.
• Additional BoC rate hikes would push the already lofty Loonie even higher. Today the Loonie trades at 80 cents with the Greenback and that’s probably already too rich for our exporters’ liking (on a related note, manufacturing employment was flat again last month). More rates rises would push the Loonie higher still.

The Bottom Line: I think the bond market over-reacted to our latest employment data and I don’t expect the BoC to do the same. That said, I continue to believe that the Bank will prove much more cautious with future policy-rate rises than the consensus now believes, and that our fixed and variable rates will remain at or near their current levels for longer than is widely expected.