What Happens to Interest Rates & Inflation in 2023? With BMO Chief Economist Doug Porter

Listen On: Apple Podcasts | Spotify | Google Podcasts | YouTube

With the Bank of Canada’s latest rate increase of 0.25% and what could be the last rate increase for 2023, what does this all mean? Don’t worry, we have one of the best in the business to tell us.

This week, Cory and Melissa welcome BMO’s chief economist Doug Porter to give us his thoughts on interest rates, inflation, the overall Canadian economy, our neighbours to the south and everything else you need to know for 2023. As one of the VCREP’s most requested guests, Doug doesn’t disappoint and makes us a little more optimistic for what 2023 has in store. This will be one you will want to listen to over and over!

What happens to interest rates & inflation in 2023? Are we headed for a recession? We sit down with BMO Chief Economist Doug Porter to get the story on the market in 2023!

Who is Doug Porter?

I’ve been an economist for over 40 years and Chief Economist with BMO for 10 years. I started my career at the Bank of Canada and have been a keen student of economics for quite a few cycles now.

Where are we at with inflation and interest rates at the beginning of 2023?

The Bank of Canada recently raised rates by 0.25% and basically told us that was it for now. Most of the reason why they had the confidence to say that is because inflation has started to cool.Core inflation is still around 5% but if you dig into the details, there’s been a clear slowing.

As long as energy prices don’t spike, we’re almost sure to see a further decrease in inflation numbers over the next few months. The arithmetic and the underlying dynamics point to inflation cooling.

In the last month, appliance prices fell at the fastest rate in a single month that we’ve ever seen. They had a big run-up a year ago and are still high, but saw a huge decline in December. That gives us a hint that prices for goods are coming down.

For all the talk of supply chain issues, it really seemed to be more of a demand story than a supply story. Everyone in the world wanted to buy a new dishwasher or new furniture. So the global supply chain got stressed and couldn’t handle the surging global demand. Now as things reopen and people are spending less on goods, there’s less demand. And we’ve seen the kinks in the supply chain get worked out.

We’re concerned that the story of inflationis no longer about the price of goods but the price of services. And the price of services is driven by wages. The key thing to watch is what happens to wages. But we are still seeing solid wage gains so it does look like a more friendly picture for inflation.

Everyone is concerned about a looming recession. Are you worried there will be a recession in 2023?

We’re expecting a milder or shallower recession over the next year. This is not your parents’ recession. What makes this cycle unique is the amount of pent-up pandemic savings that is out there. People are sitting on a lot of money, which can help consumers get through this challenging episode.

We’re actually seeing that investors are betting on a soft landing – the Canadian and US markets avoiding recession altogether. I’m a little bit skeptical but that’s what investors are betting on.

The bank’s economic forecast still predicts about 1% growth this year, which is more of a cooling than a recession.

Do you anticipate a hockey stick recovery? 

That’s a possibility. We’d probably see that in the housing market in particular. But I don’t think that’s something the Bank of Canada wants to see. While inflation has begun to cool, headline inflation is still above 6% and their target is 2%.

We have a long way to go on inflation. If the market turns too quickly – if home sales quickly start rising – that’s not good news for the Bank of Canada. They’d have to start raising interest rates again.

Is 2% inflation realistic?

That’s a good question and was an issue even before the pandemic. I don’t think there’s a clear answer. I think it is realistic to get inflation back down to 2% but it’s not going to be easy. Since they began targeting inflation back in the 90’s, it has been around 2%. So it is doable, but it won’t be easy to get there.

Does it make sense to aim for 2% inflation? That’s another good debate. There’s nothing magic about 2% so perhaps the target should be higher. But it would be a mistake to change the target while inflation is still so high. If inflation grew to 10+% in the future, no one would take it very seriously if they knew the bank could just change the target at any time.

Eventually it may make sense to adjust the inflation target, but I wouldn’t do it now in the thick of the battle.

How are the Canadian and BC housing markets in 2023? 

BC is not that terribly different from the national average, mostly because the average is dragged down by southern Ontario. Our view is we’re more than halfway through the correction in home prices. They peaked in February and are now down 13%.

We think housing prices will drop by 20-25% but again, that number is ballooned by what is going on in southern Ontario. Cities like London and Windsor rocketed during the pandemic and are already down by 20% or more.

Even though interest rates probably aren’t going much higher, if at all, the housing market is still digesting the last year of higher interest rates. I’m not convinced the market has fully absorbed that rise yet.

Where do interest rates go in 2023?

Our official view is that the Bank of Canada will hold interest rates where they are for the rest of the year. We’ve been of that view for some time, especially since the Bank was so clear in their January report.

I believe if we’re going to be surprised, it will be with the Bank of Canada raising rates a bit more this year. I don’t rule out the possibility that they will cut rates in 2023, but one of two things would have to happen: 1) inflation has to come down spectacularly 2) the economy has to weaken more than the shallow recession we’re expecting.

But most likely, I think the Bank stays stationary this year. Our view is that rate cuts are likely a 2024 story, not 2023.

Where do interest rates go in 2024? Will they drop significantly or more modestly?

Once the Bank of Canada gets going, they tend to move pretty quickly. We’re predicting a 1% rate cut for 2024; four 0.25% decreases over the year. That would get rates closer to neutral, in the 2’s for the overnight rate.

How does the US market fare in 2023? Will anything happening in the US affect us in Canada dramatically?

We think the US Fed will do slightly more than we’re doingin Canada this year; we predict they will raise another 50 basis points, and they may do more than that. The Fed basically told us they would raise rates by another 75 basis points, but we think they may slightly cool that since their inflation numbers are looking better than expected.

But keep an eye on the political game of chicken we’ll see between the White House and the House over the debt ceiling. That could cause more market turmoil in the late spring or early summer. For long term investors, it’s just noise. But it can cause some real disturbances in the short term, so it’s something to be aware of.

Do you predict more foreign investment coming into Canada in 2023? 

If you look at the Canadian dollar, it’s actually weakened over the past year. So there’s no sign we’re getting this wave of foreign investment into Canada. We also have the ban on foreign investment in real estate.

But on balance, Canada has fared reasonably well. Government finances, especially compared to most major economies, are reasonably solid. That’s a longer term source of strength for Canada.

Where would you invest in real estate in Canada in 2023? 

Over the next year or two, the prairies, especially Alberta, are a good bet. I think they’ll continue to hold up well because they didn’t have the boom during the pandemic, so won’t see a correction. Their underlying economy is also quite stable.

Longer term, I still like VancouverandToronto. Even though they’re going through a correction right now, they have wonderful long term fundamentals.

Are there any economic concerns on the horizon for this year?

The US debt ceiling drama could make some noise over the next six months. But the biggest risk right now, outside of geopolitical risk, is whether or not inflation continues to fade.

We’ve been helped a lot by a comedown in gasoline prices, but now we need to watch service prices. The labour market is still really tight so I’m concerned that inflation won’t fade away as quickly as we hoped. If that’s the case, the Bank of Canada might have to raise interest rates further.

So 2023 won’t be as bad as predicted and by 2024 we’ll be in a better place?

I think so. What determines whether we have a softening of the market or a shallow recession is what happens to inflation in the next six months. We’ll have a lot of clarity on whether or not inflation has broken by mid 2023.

The 6 Pack: Getting to Know BMO Chief Economist Doug Porter 

Favourite restaurant or bar?

I’ve barely eaten out in the last three years, so I’ve almost forgotten what’s out there. But in Toronto there’s a great restaurant called Auberge. It’s one of my favourites.

You’re on death row. What’s your last meal?

Spaghetti and meatballs!

What’s your go-to karaoke song?

I would clear the bar out with whatever I sang. Bohemian Rhapsody would definitely clear it out!

What are you binge watching?

I’m actually very new to binge watching. But I really enjoyed Yellowstone.

What’s a book you recommend? 

I had no expectations for this book but I really enjoyed it, Surrender by Bono. I’m not a Bono fan but he’s a really interesting guy and it’s a fascinating book. 

Favourite band? 

It’s so cliche but if I could only choose one, it would have to be The Beatles.

Bonus question: What advice do you have for listeners in 2023?

Despite the buoyant performance by the market, I would still play defense. You don’t have to be hyper-conservative but I would be cautious given the uncertainty around inflation and the geo-political uncertainties out there.