Soft Landing Achieved: Inflation Returns to Target in North America

Strategic Insights -

The Bank of Canada and the US Federal Reserve's aggressive interest rate hikes in 2022 seemed like a recipe for disaster, either fueling out-of-control inflation or sparking a painful recession. Instead, inflation has drifted down without a significant downturn, and interest rates have begun to fall. In August, Statistics Canada reported that the annual inflation rate touched the Bank of Canada's 2-per-cent target for the first time since February 2021. The US Federal Reserve quickly followed with a half-percentage-point rate cut, lowering the federal funds rate to 4.75 per cent to 5 per cent. This marks a milestone for the North American economy, with both countries on track for a "soft landing" where price stability is restored without a recession or widespread layoffs.

Key Takeaways:

  • The Bank of Canada and the US Federal Reserve's aggressive interest rate hikes in 2022, which seemed like a recipe for disaster, actually helped to bring inflation under control, with the annual inflation rate in Canada and the US both falling significantly.
  • The decline in inflation was faster than many expected, with some economists suggesting that it may have been influenced by the pandemic-related factors that drove inflation up in the first place.
  • Central banks are now starting to recalibrate monetary policy, aiming to bring borrowing costs down to a more neutral level before they do further damage to employment and overshoot the 2-per-cent inflation target.
  • In Canada, headline inflation hit the target in August, thanks in part to falling oil prices, but is expected to fluctuate around the target in the coming months.
  • In the US, headline inflation is still hovering around 2.5 per cent, but the Federal Reserve is signalling more rate cuts are to come.
  • Both central banks see the finish line, and want to get borrowing costs down to a more neutral level fairly quickly without causing undue damage to employment and overshooting the inflation target.
  • Sources suggest that the Bank of Canada may deliver larger rate cuts, which has so far delivered three quarter-point cuts since June, bringing its policy rate to 4.25 per cent.
  • The Canadian and US economies seem to have shrugged off higher interest rates for several reasons, including population growth, government spending, and the fact that many American homeowners have 30-year mortgages.

Statistics:

  • Canada's annual inflation rate touched the Bank of Canada's 2-per-cent target in August, for the first time since February 2021.
  • The US Federal Reserve cut the federal funds rate by half a percentage point to 4.75 per cent to 5 per cent.
  • The decline in inflation was faster than many expected, with some economists suggesting that it may have been influenced by the pandemic-related factors that drove inflation up in the first place.
  • In Canada, headline inflation hit the target in August, thanks in part to falling oil prices, but is expected to fluctuate around the target in the coming months.
  • In the US, headline inflation is still hovering around 2.5 per cent, but the Federal Reserve is signalling more rate cuts are to come.
  • The Bank of Canada has delivered three quarter-point cuts since June, bringing its policy rate to 4.25 per cent.
  • Many American homeowners have 30-year mortgages, making them much less sensitive to changing interest rates.

Sources:

  • Bank of Canada
  • US Federal Reserve
  • Statistics Canada
  • Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce
  • Beata Caranci, chief economist at Toronto-Dominion Bank
  • Jeremy Kronick, director of the centre on financial and monetary policy at the C.D. Howe Institute