Petursson admits that the BoC may start to see an odd narrative emerging from future CPI prints. The year-over-year number that tends to land on headlines is determined by removing an old month from the data and adding the new. The last four months of 2023 saw inflation sit slightly flat. That means we may begin to see a slight upward trend in year-over-year CPI going forward. Petursson argues, however, that Macklem needs to look past that trend.
Some of what gives Petursson confidence that this inflation fight is over is his view that the sudden and dramatic expansion in the money supply that emerged from the COVID-19 pandemic was the core cause of inflation. While supply chain disruptions and other factors played a role, Petursson cites the correlation between corrections in the money supply and the relative normalization of inflation as evidence.
Given his outlook, Petursson believes that a 50 basis point cut in September would be prudent. He thinks, however, that it’s presently unlikely. Markets are currently pricing in a little more than a 100% chance of a 25 basis point cut. He thinks that Macklem will follow the markets and limit his cuts to stay on the safe side.
In making the case for a deeper cut, Petersson notes just how significant a contributor shelter inflation is to overall CPI. That metric is largely driven by mortgage rates and Petursson notes that cuts to interest rates should actually serve to lower that aspect of inflation and may continue to bring CPI down overall.
In past meetings Macklem cited the risk of reintroducing froth into the housing market as potential reasons to hold back on cuts. Petursson is confident, however, that the overhang of unemployment and slowing GDP growth should be enough to keep the housing market under relative control. Other concerns around weakening the Canadian dollar have been cited as reasons to hold. Petursson notes, however, that CAD has strengthened against the USD lately, and with the high likelihood of a forthcoming cut from the US Fed in September as well, currency should give Macklem more cover.
