Finance Committee on March 23rd, 2023

[The Chair, Liberal, Peter Fonseca]

I call this meeting to order. Welcome to meeting number 81 of the House of Commons Standing Committee on Finance.

Pursuant to Standing Order 108(2) and the motion adopted on Wednesday, January 12, 2022, the committee is meeting to discuss inflation in the current Canadian economy.

Today's meeting is taking place in a hybrid format pursuant to the House order of June 23, 2022. Members are attending in person in the room and remotely using the Zoom application.

I'd like to make a few comments for the benefit of the witnesses and members.

Please wait until I recognize you by name before speaking. For those participating by video conference, click on the microphone icon to activate your mike. Please mute yourself when you are not speaking.

For interpretation for those on Zoom, you have the choice at the bottom of your screen of either floor, English or French audio. For those in the room, you can use the earpiece and select the desired channel.

All comments should be addressed through the Chair. For members in the room, if you wish to speak, please raise your hand. For members on Zoom, please use the “raise hand” function. The clerk and I will manage the speaking order as best we can, and we appreciate your patience and understanding in this regard.

I'd now like to welcome our witnesses.

With us here today from BMO Capital Markets, we have Michael Gregory, who is managing director, deputy chief economist and head of U.S. economics.

From Desjardins Group, we have Jimmy Jean, vice-president, strategist and chief economist.

From the National Bank of Canada, we have Stéfane Marion, chief economist and strategist.

Thank you for joining us today, witnesses.

We are going to provide you now with an opportunity for opening remarks for up to five minutes. We will start with Mr. Gregory from BMO Capital Markets, please, for five minutes.

[Michael Gregory, Managing Director, Deputy Chief Economist and Head of U.S. Economics, BMO Capital Markets]

Thank you, Mr. Chair and honourable members, for the invitation to appear before you as part of your study on inflation.

My name is Michael Gregory, and I'm the deputy chief economist at the Bank of Montreal. I will focus my opening comments on the Canadian economy and touch a bit on the U.S. inflation situation.

The bottom line is that Canadian inflation is coming down after peaking at 8.1%—

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

On a point of order, Chair, it's difficult for our members to see the witness speak, because this monitor is not on. Could we pause for a moment until that's rectified?

[The Chair, Liberal, Peter Fonseca]

We are having some technical difficulties with that monitor, so we'll pause briefly to see if they can get it working, and then we'll get going again.

We're back, and it looks like the technical challenges have been fixed.

Mr. Gregory, the floor is yours.

[Michael Gregory]

Thank you, Chair.

Canadian inflation is coming down after peaking at 8.1% last June, the highest rate in four decades. Data released this week showed the annual change in the CPI at 5.2% for February, and more progress looms. Some of this will be due to base effects. In the wake of Russia's invasion of Ukraine, last spring it exhibited the biggest three-month surge in prices in 40 years, at 11.6% annualized, and this won't be repeated this spring. Indeed, the latest three-month trend is running under 2% annualized.

However, the latest figures are being flattered by lower energy prices. Looking at underlying or core inflation, whether measured by the CPI-median, the CPI-trim or the CPI excluding food and energy, the yearly changes are all tucked just under 5%, and importantly, the latest three-month annualized changes are running in the 3% range. The latter are much closer to the 2% target, but further progress is still required.

Fundamentally, inflation continues to run at an above-target pace, and it accelerated in the first place because of an imbalance between demand and supply in the domestic and global economies.

After the onset of the pandemic, the demand for commodities and commodity prices was initially depressed, but it eventually recovered, in some cases quite sharply. This trend was exacerbated by Russia's invasion of Ukraine. It also didn't help that extreme weather and disease were impacting global agricultural supply.

There was a surge in the demand for goods, partly because you couldn't spend on services owing to restrictions. The strong demand butted against global supply chains that were still reeling from the pandemic, resulting in shortages and distribution backlogs. This caused many goods prices to spike.

Then, as the Canadian economy reopened, there was a surge in the demand for services, but many service providers were constrained by lack of labour. This caused some services' prices to spike, with the resulting increased demand for workers applying upward pressure on wages amid the lowest unemployment rate in half a century. Overall, Canadian demand was so strong that businesses were able to pass their higher labour and other input costs on to their customers.

Facing these mounting inflation pressures, the Bank of Canada began tightening monetary policy a year ago to dampen demand in the economy so that supply could catch up, and it's catching up.

After eight consecutive rate hikes and a cumulative 425 basis points of tightening, the Bank of Canada paused earlier this month. Monetary policy works with a lag, and the bank was keen not to weaken demand more than is necessary to restore price stability. We expect the pause will continue for the rest of this year.

Nevertheless, there's a significant chance that the Canadian economy will still see a downturn under the weight of monetary tightening, given near record-high household debt burdens. However, we judge any downturn will be mild, given the support provided by $350 billion of excess savings amassed by households, lingering pent-up demand, particularly for services, and a sturdy labour market. As for inflation, we expect the annual changes to be in the 3% range by the end of this year, down from around 5% currently, and well on track for 2%.

Finally, with President Biden visiting Ottawa today, it's worth mentioning how America's fight against inflation compares. The annual change in the U.S. CPI was 6% in February, down from its 9.1% peak last year. U.S. core inflation was 5.5%, but the three-month trend is proving to be more stubborn than Canada's, and is still running in the 5% range. Definitional differences account for some of this, but demand south of the border is proving to be more resilient in the face of Federal Reserve tightening. As such, yesterday, the Fed raised policy rates another 25 basis points, and we expect one more rate hike this spring. Given what will be 500 basis points of cumulative tightening, and the recent headwinds coming from banking sector stress, the U.S. economy is more likely to suffer a mild downturn this year, which will weigh on the Canadian outlook. We also expect U.S. inflation readings in the 3% range by year end, as in Canada.

That concludes my comments. Thank you. I would be pleased to discuss this further in the Q and A.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Gregory.

Now we'll move to the Desjardins Group, and we have Jimmy Jean for five minutes, please.

[Jimmy Jean, Vice-President, Strategist and Chief Economist, Desjardins Group]

Thank you very much. It's my turn to thank you for the invitation.

I'll begin with the global economy. In early 2023, the story was resilience. We were definitely expecting a slowdown in the pace, but the data we were receiving, particularly in January and February, showed us that the slowdown is less pronounced than we thought. We have nevertheless observed signs of improvement from the earliest days of the new year, particularly in the services sector. We were surprised by the strength of the labour markets, particularly in January and February. This was true in both the United States and Canada. However, we continue to expect a slowdown and the start of a recession this year.

In the United States, the housing sector was hard hit by interest rate hikes. For example, there was a 58% drop from the peak in new purchase offers. We are also beginning to see signs of weakness in demand for construction workers, particularly for residential construction. This indicates a potential risk of job losses, which would be added to those currently being lost in the technological and financial sectors.

Of course, the current turbulence in the world of banking will at the very least cause some permanent damage. Some American financial institutions were already tightening credit conditions. This trend will likely continue. There is little doubt that these dynamics will slow investment and job creation. It's still too early to determine the scale of the slowdown, but we can say with somewhat more certainty that the gentle slowdown the U.S. Federal Reserve was hoping to orchestrate is going to be quite a challenge.

Here in Canada, we haven't had much unexpected good news. It's not that we haven't had any, but the record wasn't as clear cut. Apart from the upswing in job creation, economic growth surprised economists by stagnating in the fourth quarter of 2022. Inflation and the real estate market have moved apace, generally downward. Consumption by Canadian households had highs and lows. For example, in the third quarter of 2022, the province of Ontario experienced its sharpest drop in consumption since 1992, apart from during the pandemic.

Still, the more recent indicators show some gains in Canada, influenced among other things by motor vehicle shipments as supply chains improve. However, this will likely be temporary, and several surveys have confirmed that Canadians' interest in major purchases is at a particularly low level.

As mortgage borrowers renew their contracts at higher interest rates, the additional hit on their disposable income will require them to cut back on their spending and draw upon their savings, at least for those who were able to set money aside during the pandemic, which is certainly not the case for all households. Others will want to repay their debts. In short, discretionary consumption will be affected.

That will also be the case for income in some households. For example, people with jobs in sectors that are vulnerable to the real estate correction and interest rates may experience financial problems. The current increase in household and business insolvencies will also likely continue.

The problems currently affecting banks outside Canada could be an additional factor that could lead financial institutions, including here in Canada, to exercise greater caution, which would of course be reflected in increased credit, and business credit in particular, which has been fairly resilient so far.

According to the information we currently have, even if the Bank of Canada has likely completed its interest rate hike cycle, it may well maintain a high level until the end of the year. This, combined with quantitative belt-tightening, which we believe is more serious here in Canada than in the United States, creates conditions that would keep Canada in a recession for the next few quarters and cause the unemployment rate to start rising.

We are expecting Canada's unemployment rate to reach 6.9% by year-end, and it was 5% in February. The labour shortage should mitigate the impact of the decline in aggregate demand on unemployment. That's why we are expecting this recession to be narrow in scope, historically speaking. Nevertheless, it's important to acknowledge that at the moment, global financial events are showing a balance of risks that is trending downward.

Even though the Canadian banking system is built on rather solid foundations, the 2008‑09 financial crisis reminds us that Canada is not fully immunized against the kinds of indirect economic impacts that generally arise in episodes like these.

As for inflation, it should continue to moderate. We don't think that it will reach the 2% target until next year, particularly because of the persistent issues with housing, food, and certain services. The year-end inflation range, which we expect to be 2% to 2.5%, should give the Bank of Canada a sufficiently high comfort level for it to begin gradually making its monetary policy more flexible, and putting an end to quantitative tightening.

In our baseline scenario, this monetary easing, to which the U.S. Federal Reserve will also have to contribute in 2024, and the component that would begin to pave the way for an economic recovery—

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Jean.

We have just gone a little over time. We are going to now move to the National Bank of Canada. I have Stéfane Marion. Just before you commence, Mr. Marion, I would like to ask Michael Gregory to move the boom on his mike a little higher.

In terms of the pace of your speaking, gentlemen, please don't go so fast, because we have interpreters, and they're trying to keep up. It's difficult work for them, so please speak clearly and at a reasonable pace.

We have Mr. Marion for five minutes, please.

You may need to unplug and replug your headset.

Can you hear us, M. Marion?

[Technical difficulty—Editor]

Monsieur Marion, we have only certain approved headsets here for Parliament. We will give you a call. Just stand by, and you will be getting a call from our technical department.

Members and witnesses, we're going to start into our first round of questions. If we do get Mr. Marion back on, we will interrupt at one point and allow him to make some remarks and then get back into questions.

We'll start with the first round right now. We have the Conservatives, with Mr. Morantz, for six minutes, please.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you, Mr. Chair.

It's very nice to have our esteemed witnesses with us today.

I want to start with the elephant in the room, which has to do with what's been going on in the banking sector, mainly in the United States, the catalyst of which was what happened with the Silicon Valley Bank.

Since this is a public meeting, I was wondering if you could give some reassurance to those who may be watching that Canadian banks are not at risk, and that the Canadian banking system will remain on solid ground despite what's going on internationally. Any one of you could take that.

[Jimmy Jean]

I can start.

I think that, in what we're observing, it's important to realize that what we're seeing in the United States really starts with very idiosyncratic factors and conditions affecting specific banks. We're talking about a banking system with 7,000 banks. It's not the same type of management that we have here, in a system that has seven major banks or financial institutions.

There were regulatory gaps that were obviously the effect of very fast-rising interest rates and some troubles in managing that risk in certain banks' balance sheets, obviously combined with an electronic bank run, which goes much faster, as we've discovered, than those long wait lines. All those factors, I think, combine to produce what we're seeing. Then there's the confidence aspect, which produces fragilities elsewhere.

In the case of Canada, our system has been, I think, consistently demonstrated to be resilient. That was the case even in 2008-09, which was orders of magnitude more complicated and featured credit issues and toxic assets, and our financial system ended up being quite resilient. We ended up importing the negative effects on our economy, but our banks were sound. If anything, they have been reinforced by very tight and sound regulation since then.

I'm not concerned that we might see something like this in Canada; however, what's going on certainly means that credit is going to be slowing down further. It was already slowing down in the U.S. It's going to slow further. We might see that as well in Canada as we see a bit of prudence on the part of certain financial institutions, so it reinforces the idea that we are going to see a recession as a result.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you for that.

Last fall there was an article in The Economist, assessing housing risk. It ranked Canada as number one in terms of housing risk. The Netherlands was second. The United States was seventh, and Italy was seventeenth.

The article said that bringing this altogether, all the ingredients for a deep housing slump are in place. This time, though, it's likely to be led not by America but by Canada, the Netherlands, Australia and New Zealand. Economists at the Royal Bank expect the country's volume of sales to plummet by more than 40% in 2022-23, exceeding the 38% drop in 2008-09. That article was published in October last year.

Can you comment on whether or not you agree with that assessment, and whether six months later we're seeing that prediction in reality?

Any one of you can take it.

[Jimmy Jean]

There's no question that the Canadian housing market is correcting. We're seeing on a nationwide basis more than double-digit declines from the peaks we had, but a couple of things are interesting.

Number one is that even though home sales are falling, suggesting that the demand for homes themselves has fallen in the wake of higher interest rates, the availability of homes is also falling commensurately. There's not a lot of forced selling out there. There are not a lot of people stretched beyond their means. I think, because of that, this isn't a 2008-09 situation. Canadian financial institutions are very prudent lenders. Canadian households tend to be very prudent borrowers, which was not the case in the United States, as you know, during the great recession and the global financial crisis that preceded it.

I think, yes, we're getting a correction. It's going to be a drag on economic activity. It will likely contribute to the risk of a downturn, but I think it is manageable and containable, so I'm not at all worried that this is going to spark an even larger problem in the economy.

[Marty Morantz, Conservative, Charleswood—St. James—Assiniboia—Headingley, MB]

Thank you.

[The Chair, Liberal, Peter Fonseca]

Thank you, Mr. Morantz.

[Jimmy Jean]

Maybe if I can add to that—

[The Chair, Liberal, Peter Fonseca]

Monsieur Jean, we're done with the time right now for Mr. Morantz.

Before we go to our next questioner, who is Liberal MP, Mr. Baker, we're going to try again with Mr. Marion, to see if it works this time and if we have those technical challenges fixed.

[Stéfane Marion, Chief Economist and Strategist, National Bank of Canada]

Can you hear me now?

[The Chair, Liberal, Peter Fonseca]

We can hear you. You have five minutes for your opening remarks.

[Stéfane Marion]

I didn't hear you.

[The Chair, Liberal, Peter Fonseca]

Raise your mike a bit. You have five minutes.

I don't know why you can't hear us.

[Stéfane Marion]

I can hear you. There's a—

[Simon-Pierre Savard-Tremblay, Bloc, Saint-Hyacinthe—Bagot, QC]

Mr. Chair, I have a point of order.

It's impossible to understand the interpretation because of the sound quality.

[The Chair, Liberal, Peter Fonseca]

You have five minutes now, Monsieur Marion.

[Stéfane Marion]

I apologize.

I hope you can hear me clearly.

I'm here to present some facts that will be complementary to the presentations from my two colleagues.

As you well know, hindsight is 20/20 vision, and inflation is a lagging indicator that reflects the previous mix of fiscal and monetary policies. That said, far be it from me to lecture on how best to navigate a pandemic environment in the context of a dysfunctional global supply chain and acute geopolitical stress.

[The Chair, Liberal, Peter Fonseca]

Monsieur Marion, it may be the speed that you're going at—