Canada – The consumer price index dropped 0.2% in August

Week in review

Canada – The consumer price index dropped 0.2% in August, allowing the year-on-year inflation rate to decline two ticks to 1.1%. In seasonally adjusted terms, CPI was down 0.1% as higher prices for health care, clothing, shelter and household operations were more than offset by a decline in recreation/reading and food. The core CPI, which excludes eight of the most volatile items, was flat, which allowed the annual core rate to drop three ticks to 1.8%, the lowest in two years. In seasonally-adjusted terms, core CPI was flat. Goods prices are moderating, suggesting perhaps that the effects of earlier C$ depreciation are fading. Services inflation was also weak in August. Assuming September core inflation is in line with historical norms, core CPI should average 1.9% on a year over year basis in Q3, slightly below the Bank of Canada’s Monetary Policy Report estimates of 2.0% published back in July.

Retail sales fell 0.1% in July, disappointing consensus which was looking for an increase of 0.1%. In July, sales fell in five of the 11 subsectors, including autos. Excluding autos, sales fell 0.1%, also disappointing consensus which had expected an increase of 0.5%. Gasoline station receipts were down sharply in the month in line with sinking pump prices. But there were also lower revenues for sellers of furniture/home furnishings, food/beverage, and health care products, which more than offset gains for sellers of electronics, building materials, sporting goods, general merchandise and miscellaneous items. Looking at provinces, on a year-on-year basis, BC leads the way (+6.4%), while Quebec (+3.8%) and Ontario (+3.3%) are also well above the national average of 2.3%. Newfoundland & Labrador (-3.9%) and Alberta (-3.8%) continue to struggle. In real terms, Canada’s retail sales rose 0.3%, something that will give a boost to July GDP. The quarterly picture is also looking good. Even assuming no change in August and September, real retail sales are on track to grow in Q3 after contracting the prior quarter.

Wholesale sales rose 0.3% in July, with gains in five of the 7 broad subsectors, including motor vehicles. In real terms, wholesale sales were up marginally (+0.05%).

In a speech this week, Bank of Canada Governor Stephen Poloz talked about macroeconomic and monetary policy aspects of ultra-low interest rates. He said that interest rates are low for reasons that are not necessarily controlled by central banks. For instance, the real neutral interest rate has come down globally over the years due to the decline in the potential growth rate (courtesy of an aging population and lack of investment) and the growing influence of developing economies (which tend to save more than advanced economies). For Canada, the central bank estimates that the real neutral interest rate, i.e. one that is neither stimulative nor contractionary, is in the 0.75–1.75% range (i.e. a nominal neutral rate of 2.75– 3.75%, which is 1.75% below pre-crisis levels). The Governor gave some explanations about why investment has been so weak in Canada. He blamed “the high level of uncertainty” but also the reluctance of corporations to lower their “hurdle rates”. The hurdle rate ─ the lowest rate of return that a company will accept before undertaking an investment ─ should be a function of the risk-free rate and hence the real neutral rate. The Governor bemoaned that firms haven’t yet factored in the lower real neutral rate of interest, meaning that hurdle rates are higher than what they should be. He added: “if companies are maintaining traditional hurdle rates, they are unlikely to invest any time soon, and we will not see the kind of growth, productivity and job creation we are looking for.”

Corporations and government can help in raising the economy’s potential growth rate and Governor Poloz gave some recommendations. Businesses have to adjust their expectations about investment returns to “reflect the current and likely future reality and reconfigure their investment plans accordingly”. As for government, the Governor recommends tax and immigration policies that “are as enabling as they can be (for investment)”, infrastructure investments, defending existing trade arrangements and pursuing new ones. He gave concrete examples, “TPP could add a further one- or two-tenths to our potential output growth... while the removal of interprovincial trade barriers could add one- or two-tenths of a percentage point to Canada’s potential output annually.”

United States – Housing starts fell 5.8% in August to a three-month low of 1142K in seasonally adjusted annualized terms. There were declines for both single family homes (-6%) and multis (-5.4%). Building permits dropped 0.4% to 1139K in August as declines for multis (-7.2%) more than offset gains for single family homes (+3.7%).

Existing home sales fell 0.9% in August to 5.33 million units. The decrease was entirely due to single family units (-2.3%) which more than offset gains for multis (+10.5%). The months supply of homes at current sales rate fell marginally to 4.6 months. The median resale price fell to $240,200 but is still 5.1% higher than year-ago levels (+5.3% for singles and +3.7% for multis). Only 22% of August sales were made to cash buyers, while the share of distressed sales in total sales was just 5%, both close to multi-month lows.

Markit’s flash/preliminary estimate of the manufacturing purchasing managers index ended up at 51.4 in September, down from 52 the prior month. A reading above 50 implies expansion in manufacturing activity. Output and new orders expanded at a slower rate than the prior month, while employment picked up speed.

Initial jobless claims fells to 252K in the week of September 17th. The more reliable 4-week moving average dropped further to reach 259K. Continuing claims for the prior week fell 36K to 2.11 million.

As widely expected, the Federal Reserve left monetary policy unchanged. The fed funds rate remains between 0.25% (lower bound) and 0.50% (upper bound). The Fed was encouraged by continued strengthening of the labour market and a pick-up in economic activity after a difficult first half. However, inflation remains low and investment is soft. Near-term risks to the economic outlook “appear roughly balanced”. The FOMC said the case for an increase in the federal funds rate has strengthened but it decided, for the time being, to wait for further evidence of continued progress toward its objectives. The ranks of dissenters grew in September as Esther George was joined by Loretta Mester (another hawk) and Eric Rosengren (a dove at one point). All those folks wanted a rate hike to 0.50-0.75%. While the labour market is strong, the Fed thinks more progress can be achieved as to allow wage growth to pick up and give itself a better chance of eventually hitting its 2% inflation target. Median forecasts of FOMC participants show just one rate hike slated for this year, two hikes in 2017, three hikes in 2018 and another three in 2019. We continue to expect this year’s sole rate increase to be in December rather than at November’s meeting which is just a few days before the elections.

World – The Bank of Japan adopted a new framework for conducting monetary policy dubbed “Quantitative and qualitative monetary easing with yield curve control”. The central bank will not target the money supply anymore but will instead focus on controlling bond yields across tenures. The central bank will purchase a wide range of maturities of JGBs giving it more flexibility to control the yield curve, although the amount of 80 trillion yen/year remains unchanged. The BoJ also committed to expand the monetary base until the year-on-year CPI inflation rate exceeds the 2% target in a stable manner. The central bank will continue to charge financial institutions 0.1% on balances held at the central bank.

Flash manufacturing purchasing managers indices for the month of September were released by Markit for a range of countries. Japan’s PMI rose to 50.3 (from 49.5 the prior month). While output and employment expanded, new orders remained in contraction mode. The eurozone’s PMI rose to a three-month high of 52.6 thanks to gains in Germany and France. Markit also released services purchasing managers indices for September, with the eurozone’s measure falling to a 21-month low of 52.1, the decline driven by Germany.

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