Canadian unemployment could exceed 7% if interest rates aren't cut soon

Canada's unemployment rate is on track to reach or exceed seven percent this year if the Bank of Canada (BoC) doesn't implement interest rate cuts "sooner rather than later," a National Bank economist cautions.

The labor market is "struggling" and should not be overlooked due to an exclusive focus on inflation figures, wrote Taylor Schleich, director of economics and strategy at National Bank Financial Markets, in a note published Monday.

"In our view, a July rate cut should be considered a likely outcome, unless a severely disappointing June CPI report keeps the BoC on the sidelines."

Schleich notes that while the May inflation data "wasn't ideal," it's important not to "miss the forest for the trees" regarding unemployment indicators, as "inflation has been much more controlled" than in recent times.

"If left unchecked, an unemployment rate of seven percent or more could be expected this year if the recent negative trends in the labor market continue."

The Bank of Canada made its first interest rate cut in over four years in June, reducing its benchmark rate to 4.75 percent. The next rate announcement is scheduled for July 24, but market opinions are divided on whether another cut will occur.

Canada's June labor market data was weaker than most analysts had anticipated, showing a net loss of 1,400 jobs, which nudged the unemployment rate up to 6.4 percent, a 0.2 percentage point increase. This rate has been gradually rising since a post-pandemic low of under five percent in 2022 and at a faster pace than many comparable countries. "The 1.6 percent increase from the 2022 low is the largest in the G7," Schleich noted, and fifth in the OECD.

Economists generally agree that the unemployment rate at which inflation should theoretically remain stable (known as the non-accelerating inflation rate of unemployment, or NAIRU) is around six percent, Schleich wrote in an email to Yahoo Finance Canada.

"So we're at or slightly above that level, but it's increasing rapidly," he said. "Given that there are lags in monetary policy" — meaning interest rate changes don't tend to have an immediate impact on employment figures — "we argue that the BoC needs to cut relatively quickly to stabilize those figures before they get too high."

In the National Bank note, projections extending the three- and six-month average trends for unemployment increases show the rate reaching 7.5 percent next spring — an outcome that interest rate cuts would be expected to counter.

Though some economists have pointed to still-strong wage growth rates as a reason for the BoC to delay cuts, Schleich notes that wage growth figures are typically a lagging indicator.

"A slowdown in wage growth should follow from the softening in labor market conditions eventually. There's just no reason to be paying ever higher wages when more and more workers are on the sidelines."