“Economy is weak, but it is not clearly in recession”: Bank of Canada governor says

Economic weakness, combined with rising inflation, is a dilemma for monetary policy. Raising rates to dampen inflation could further slow the economy. Easing rates to support growth increases the risk that higher inflation becomes persistent. For now, holding the policy rate unchanged balances those risks. However, uncertainty is unusually elevated, and the risks could shift. Monetary policy may need to be nimble. If the United States imposes significant new trade restrictions on Canada, we may need to cut the policy rate further to support economic growth. Alternatively, if the conflict in the Middle East continues and higher energy prices start leading to ongoing generalized inflation, monetary policy may have more work to do. There may be a need for consecutive increases in the policy rate. Of course, these are not the only possible scenarios. The Canadian economy is working through a period of structural change. Shifting trade relationships, the adoption of AI, and changes in demographics complicate the assessment of the economy. We're going to be watching all these developments closely and assessing their implications for growth and inflation. And as the outlook evolves, we stand ready to respond as needed. The bank is committed to ensuring that Canadians continue to have confidence in price stability through this period of global upheaval. And with that, two of us will take your questions.

David, it's less about a timeline and it's more about the conditions. So, what are the things that we're going to be looking at? What we don't want to see is a big rise in energy prices turn into generalized inflation. And then, we don't want that to become persistent inflation. So, how do we assess generalized? Right now we're seeing very limited evidence of pass-through of higher energy prices to other goods and services. Obviously, you can see some effects. You're seeing surcharges on airlines, for example. But broadly you're not seeing much pass-through. How do we assess that? Well, core inflation which strips out the increase in energy prices, it's actually ticked down. If you look at the proportion of CPI components that are rising faster than 3% is close to its historical average. So, so far there's very limited evidence. But, if we started to see more evidence that higher energy prices were passing through to other goods and services, that would certainly get our attention. That would be a source of concern. And then, yes, the other thing you look for is persistence. And there, things like looking at inflation expectations. Naturally, with higher inflation, near-term inflation expectations have gone up. Inflation has gone up. So, of course near term inflation expectations have gone up. So far we're seeing longer term, medium term inflation expectations are remaining well anchored, but if you started to see those drifting up, that would be a sign that inflation is becoming entrenched and the persistence is likely to go up. So, those are really the things we're watching for. It's less about the timeline. It's more about the conditions.

Well, that's certainly part of it. I think just to back up for a minute. I mean, part of it is that we started with 2% inflation. I mean, inflation until the war in the Middle East was running close to 2% for roughly a year and a half. So, we had inflation back to target. It has moved up, but it started lower. So, it's still lower in the United States. There are some other factors pushing inflation up in the US and you know, there's no question US tariffs have boosted US inflation. But that effect is probably going to start to wane unless they take new trade actions. And as you mentioned, yes, the Canadian economy is soft. It's weak. And that tends to put a downward pressure on prices generally. We have not seen any evidence yet of broad-based pass-through of higher energy prices to other goods and services.

Well, I'll dig in a little bit on the GDP number in a minute, but the big picture not a great deal really has changed since our last decision. Worries on the macro still ongoing. The uncertainty about US trade policy remains. The review of CUSMA is ongoing. And the data overall has not been big surprises. Yes, fourth quarter GDP was quite a bit weaker than we thought. But if you look under the hood, consumption grew 1.4%. You're still seeing consumer spending expanding. The miss was largely because there was an unexpected pullback in government spending. It can be difficult, government spending can be choppy one quarter to the next. We don't think there's any sort of ongoing shift in government spending. The government have announced their plans. We built those plans into our projection. Figuring out exactly how that plays out quarter to quarter is difficult. You look at Q1. So, consumption was fairly healthy. Housing pulled certainly, housing declined. Business investment was soft. And then your trade and inventories were largely awash. That gave you a very slightly negative quarter. We do think growth will resume in the second quarter. We expect to see continued expansion of consumer spending. We think there'll be a little more stability in the housing market, so they won't be subtracting from growth. So we do expect growth to resume. And if you look at the labor market, month to month, there's been a lot of volatility in employment. The last month was up strongly. If you look over the last 6 months, basically, employment is roughly unchanged. The unemployment rate's been fluctuating in a range of 6.5 to 7%. So that hasn't really changed since last time.

Look, the short answer to that question is, based on the data we've seen to date, the economy is weak, but it is not clearly in recession. So let me just unpack that a bit for you. If you look at how the economy has evolved over the last year, GDP is roughly flat over the last 12 months. If you look at the labor market, it's up a little bit over the last 12 months. Essentially flat over the last 6 months. As I mentioned, there's been a lot of volatility month to month, quarter to quarter, but when you look through the bumps, the economy hasn't really grown in the last year, but it hasn't shrunk either. So, economists typically define a recession as a significant, broad-based decline in economic activity that lasts for more than one quarter. And if you look at the data we've got, based on that definition, the economy is weak, but it's not clearly in a recession. If you look at the first quarter was just barely negative after the decline in the fourth quarter of last year. If you look across industries, what you see is that in the first quarter, more than half of industries actually grew, expanded on a year-over-year basis. And as I mentioned, the unemployment rate's been relatively stable in the 6.5% to 7% range. So, so far, we have not seen a significant, broad-based decline in economic activity. So, recession is not the word I would use. I would describe the economy as weak. It hasn't grown really in the last year. There's excess supply in the economy. There's slack in the labor market. We're certainly assessing that closely and as we indicated, we're prepared to respond as needed.

No, we're continuing to balance both risks we described. The oil risk is one risk. If we see oil prices increase further, if we see them sustained at a very high rate, and most importantly as the Governor just described, if we see that start to feed into broader based price increases, that's a risk we'll need to react to. On the other hand, we still have this trade uncertainty overhanging the economy that could weigh on growth. We could get further trade action. We could get further deterioration from the sense of uncertainty we have. That's a risk we'd have to react to as well. What we're telling you today is we see those risks continue to be about where we saw them last time. The economy continues to be about where we thought it was last time, which means we've got the rate where we think it needs to be right now. We've got a forecast in a few more weeks, and we'll be taking all the data in and where we're at then.

Yes, as you've indicated, what all parties are indicating is that there is a lot of deal. Discussions are ongoing, negotiations are ongoing. They're probably going to play out over a number of months. So, yes, that uncertainty will continue to weigh on the economy. The good news is with the exception of the hard-hit sectors, the vast majority of goods and trade with the United States continue to be traded tariff-free. I think businesses are starting to recognize that our trade relationship with the United States is changed and that uncertainty is even with a deal, I don't think you can be certain about anything. So businesses are having to adjust to that. They're adjusting to that uncertainty. They are diversifying their trade. They're also to some extent just getting used to the new reality and getting on with business. Maybe if you look at our last business outlook survey, you could see that in the responses of businesses. Even though the uncertainty hadn't gone away, they were starting to make investment plans. I'm not saying the uncertainty wasn't weighing on them. But they were starting to recognize, okay, we can't just sit on our hands forever. This isn't going away. We've got a business to run. We've got to manage in an environment of uncertainty. And you're starting to see businesses get on with it. So we are expecting to see, at least in our last projections, Senior Deputy Governor mentioned it. We'll be updating that with our July projection and we'll be getting a new business outlook survey as well. So we'll see how things are evolving, but based on the last one, we have some modest pick up in business investment going forward after a lot of weakness.

Well, look. The war in the Middle East is still going on. There's no clear resolution in sight. We don't know what that resolution would look like. There's been damage. So, yes, this is probably, the fact that the energy price futures curve has shifted up I think is reflecting that. And look, the longer this goes, the higher energy prices are, the longer they're higher, the bigger is the risk that that starts to pass through to other goods and services. And it's the more likely that then we need to respond. So, that is certainly a concern and we've been very clear. We're not going to let war in the Middle East become an inflation problem here in Canada. But that's not the only thing going on. There is a lot going on. We've been talking about trade, Canadian economy is going through a period of restructuring. Adoption of AI, lower population growth. So, we've got to look at all these things together. Based on our assessment of where inflation's going, how the economy's doing.

Both, is the short answer. That's the reason we're talking about both of them. Look, clearly, as I've just said, clearly the war in the Middle East, it's ongoing. The longer it goes, the higher energy prices are. And in particular, the longer they stay high, that risks a one-off increase in energy prices becoming more persistent inflation. That's what we can't let happen. We're committed to getting inflation back to our 2% target over time. We're prepared to look through the near-term impacts or what you might call the first-round impacts, but when you start to see second-round impacts, you start to see more persistent, that's certainly a signal that monetary policy has more work to do. But yes, look, trade remains very uncertain. The discussions, the negotiations remain ongoing. Hopefully, that lands well. And the Canadian economy can, we can restore more certainty in our relationship with the United States. You can see it, I think if that happens, you'll see more strength in exports, more strength in investment. That'll be good to the economy. But look, we have no influence on that outcome. We're going to take things as they come. There are risks on both sides. They're both important.

So, look, our base case on CUSMA is that the negotiations continue to play out for a number of months. So, we haven't built in a big change one way or the other there in terms of our outlook. In terms of what is the evidence for the second quarter? We do have some higher frequency indicators for the second quarter, which can give you some advanced perspective on where it may land. If you look at things, so there's a flash GDP estimate for Stats Can. That was fairly positive for the first month of the quarter. We have some higher frequency data for consumption, for housing. Consumption so far looks like it's holding up. Consumption growth and housing, which did decline in the last quarter, looks like it's more stable. I don't think it's going to be a big contributor to growth based on the high frequency data we have so far. But based on that data, looks like it's stabilizing, so it shouldn't subtract from growth. Yes, look, I'll be the first one to admit that although we're actually well into the second quarter, we don't have that much data yet. There's always uncertainty. We've seen a lot of volatility in the month-to-month data, but when you look at our surveys, you look at the high frequency data we have, we do think the Canadian economy is poised to return to growth in the second quarter.

Well, Max, that's one of the decisions the central bank makes. I mean, what you're describing is the risk we've been talking about in the answer to other questions, which is the risk that higher commodity prices start to spread into other goods and services. If that happens, our job is to deal with the inflationary impacts. Direction on how to conserve energy is well outside our mandate.

No, I think we'll move on.

Well, first of all, let me clarify how we think about the 1 to 3% range. First of all, the range, our target is for total CPI inflation, and the range, it is the 2% midpoint of a 1 to 3% range. You shouldn't think of the range as a hard boundary. You should think of the range really more as a way to try to help explain to people what is kind of the normal variation of inflation. So, I mean, if you look over history, at least pre-COVID, total CPI inflation was within the 1 to 3% range 80% of the time. Obviously, we have a 2% target. We can't literally hit 2% every month, but 80% of the time it's bouncing around in the 1 to 3% range, and I think, as long as it's in that range, well, it's a pretty normal state of affairs. Occasionally, there are big shocks that can push it outside of the range. And it's on us to explain, okay, why is it outside of the range, and what are we going to do to get it back into the range? So, we use core inflation really more, especially in this context, as a tool to help us understand how generalized price increases are. If the only reason inflation goes up is because of one price, higher oil prices, higher gasoline prices, or a small number of prices related to energy, that's more of a relative price shock. And it's not really inflation. So, it tends to be something we would look through. We tend to look through the first round effects, particularly when there's some weakness in the economy, which reduces the risk that it's going to get passed through to other goods and services. If we start to see core inflation drift up, because higher energy prices are spreading, that is certainly something that would get our attention because that would suggest that CPI inflation is not going to come down to the target. And we might have to take some action to get it to come down to the target. So, I hope that helps you think about the role of the band.