Bank of Canada governor says job market is cooling

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Signs that central bank’s effort to tame inflation is working

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Bank of Canada governor Tiff Macklem said recent data show the labour market is cooling, and that he remains confident that an unusually high number of job vacancies absorb some of the negative impact of higher interest rates, signals the central bank thinks its efforts to constrain inflation are working.

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“In recent months, we’ve seen initial signs that these exceptionally tight labour market conditions have started to ease,” Macklem said in a speech hosted by the Public Policy Forum in Toronto on Nov. 10.

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Canada’s unemployment rate was 5.2 per cent in October, up from a record low of 4.9 per cent in June. Macklem also flagged slower wage growth and a significant drop in job vacancies as evidence that the sharp increase in interest rates that he orchestrated this year are doing their job by turning down the heat on an economy that the central bank thinks is growing too fast.

“Job vacancies have started to decline,” Macklem said. “Their softening has been evident in sectors that are more sensitive to interest rates, such as manufacturing and construction.”

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Macklem’s assessment of the state of the labour market was significant because he is trying to execute a manoeuvre that many Bay Street economists think is impossible: crushing inflation with higher interest rates without simultaneously causing a job-killing recession.

At this stage, Macklem said he expects the high rate of vacancies could help steer the economy away from the high unemployment that typically comes with a recession, as the Bank of Canada uses higher rates to rebalance the “unsustainably tight” labour market.

The way Macklem described the adjustment was that high rates would slow spending, which would then contribute to lower demand for goods and services, and then the labour needed to provide it.

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“Given that we’re in a period of very high vacancies, that adjustment could be more through vacancies,” Macklem said at a press conference. “That doesn’t mean that it will be painless,” Macklem added. “If you’ve got less vacancies, if you’re looking for a job, it’s probably going to take you a little longer to find a job. So that means the unemployment rate will go up.”

Macklem added that the central bank isn’t expecting the same increases in the unemployment rate compared to past recessions, which he noted saw unemployment increases between three to six percentage points.

“We’re talking about something considerably less than that,” he said.

Record job vacancies

The reason Macklem argues that’s possible is because there are so many job vacancies in Canada: a record of more than one million in the second quarter. The central bank has raised the benchmark interest rate by more than three percentage points since March, a shock that risks a recession and mass firings. Macklem argued that the risk was reasonable because job vacancies would act as a shock absorber: instead of job cuts, he bet employers would respond by taking down “help wanted” signs instead.

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“With more modest spending growth, the demand for labour by businesses will ease, vacancies will decline, and the labour market will come into better balance,” Macklem said. “This will relieve price pressures.”

The notion that job vacancies will cushion the real-world blow of higher interest rates hasn’t won over all economists, even though the data support the governor’s logic. Since the first three months of 2020, Canada’s job vacancy rate has surged to 5.9 per cent from 3.1 per cent. That suggests demand got ahead of fundamentals.

Still, many of those vacancies were in the technology industry, and some of the biggest companies in that sector are now firing tens of thousands of people. E-commerce heavyweight Shopify Inc. cut 10 per cent of its workforce in late July as the pandemic-fuelled growth tapered off, and this week Meta Platforms Inc. slashed more than 11,000 positions.

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Unreliable barometer?

Against this backdrop, some economists are hesitant to call the vacancy rate a reliable barometer for labour market strength and a safe bet that the economy could take another rate hike beating. Employ America, a think-tank, warned that labour market indicators reflect a strong recovery following the pandemic, but vacancies could make the economy appear stronger than it actually is.

Stephen Tapp, chief economist at the Canadian Chamber of Commerce, said the playbook may be shifting in the current economic environment. Tapp said whether these job vacancies could absorb the economic effects of higher rates or a market downturn was a key question for Canadian labour market dynamics moving forward.

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“It’s certainly possible that the big build-up of vacant jobs could act as a shock absorber during a future labour market downturn,” said Tapp. “However, that ideal ‘soft landing’ scenario isn’t something we should be overly confident about, nor should it be the base-case planning scenario going forward.”

Tapp cautioned against oversimplifying the situation: vacancies often reflect a shallow pool of qualified workers, not necessarily excess demand. That means higher interest rates could still cause companies to cut existing staff if the economy drops into a recession.

“I would just say, while it’s certainly possible we could see a soft landing in Canada’s labour market, what’s happened so far suggests that’s not the most likely short-term outcome,” Tapp said.

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Difficult path

Over the summer, Macklem conceded the path towards a soft landing from the post-pandemic surge in growth was narrowing. The latest findings in the monetary policy report published in October highlight that gross domestic product increased 1.5 per cent in the third quarter, down from a previous estimate of two per cent. The central bank forecast that the economy would slow to an annual rate of 0.5 per cent in the final quarter of the year, and expand only 0.9 per cent in 2023.

Sébastien Lavoie, chief economist at Laurentian Bank, said the ratio of unemployed workers to job vacancies might be at a record high, but it provides an incomplete measure of the broader labour market. Lavoie predicts the jobless rate is headed to about six per cent in 2023, a significant shift from recent levels.

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“There is also a limit to draw comfort with the job vacancies buffer,” Lavoie said, observing that Statistics Canada points to job vacancies being at an all-time high, while postings on recruitment website have declined in Quebec, Ontario and British Columbia. “It is not because job postings are high that employers’ appetite to hire is still there.”

Cautionary tale

Still, the stagflation of the 1970s, where unemployment rose by three percentage points peak-to-trough, might also be a cautionary tale. Lavoie argued Macklem could use this chapter in history to justify a super rapid tightening cycle to avoid harsher outcomes, as even an unemployment rate of around six per cent would be decent by historical standards.

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The latest jobs data suggests there’s still an appetite to hire. Employers created 108,000 new positions in October, compared with Bay Street expectations of around 10,000. Economists at the Big Six banks took this as a sign that the economic ‘sky is falling’ scenario has yet to happen and could add pressures on the Bank of Canada to go bigger with rate hikes.

The Bank of Canada will have to keep a keen eye on the pace of wage growth, which rose 5.6 per cent year-over-year in the latest jobs reading. Higher wages imply upward pressure on inflation because households have more money to spend, and employers will be seeking to make up for salary increases by raising prices.

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Charles St-Arnaud, chief economist at Alberta Central and a former Bank of Canada staffer, argued that the reliability of the jobs vacancy buffer largely depends on how deep and sustained the anticipated recession next year will be. He said that for the employers in the sectors most deeply affected by labour shortages, they may think twice about going straight to job cuts if it means facing the difficulty of getting them back on the payroll.

“It might help to provide a buffer for job cuts because (for) some employers if you are in sectors where it was very hard to get the workers you needed, you’ll probably be a bit more wary of laying off those workers because it will be hard to hire them again,” said St-Arnaud. “You might bite the bullet and keep them on your payroll longer until you really you don’t have a choice.”

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