Interest rate hikes caught some by surprise. Here’s what’s behind it.
In June, the Bank of Canada announced that it had increased the target for the overnight interest rate to 4.75 per cent.
This may come as a surprise for many Canadians, as the narrative in the media has been, for many months now, that the late 2022 interest rates increase would lead to a slower economy, and thus lower rates, in the first part of 2023.
As I have done in the past, I am using this opportunity to give dealers broader economic context, go over what led to this interest rate hike and highlight how it might affect dealers for Q3 and Q4.
First and foremost, the Canadian GDP has seen growth of almost 3.1 per cent over the last 6 months. Even when adjusted to population growth, this economic vitality has been driven by a robust increase in consumption across a large array of goods and services — which in turn led to sustained labour demand.
Usually perceived as a reliable precursor of what’s coming next in the economy, housing market activity has also been on an upward trend despite what most economists anticipated.
The recent economic uptick has led to an increase in inflation, the first one in more than 8 months, and thus motivated the Bank of Canada to continue its quantitative tightening.
Even when adjusted to population growth, this economic vitality has been driven by a robust increase in consumption across a large array of goods and services — which in turn led to sustained labour demand.
The steady economic activity has also been observable for the automotive industry. In fact, auto sales in Canada have increased by more than 10 per cent in May compared to April and sales have gone up by 13.5 per cent compared to May of last year1.
While these results are positive and act as a reflection of the overall strength of the economy, sales numbers are still not anywhere close to pre-pandemic levels.
There is a silver lining: inventory levels have increased steadily but are also still lagging behind 2021 levels. Per a survey led by Desrosiers Automotive Consultants, dealers are saying that on average inventories are at 42 per cent of normal. With sustained consumption levels, it is fair to assume that low inventories have contributed to dealers’ difficulty in capturing some of the demand — demand that, for many reasons, wasn’t expected this late in 2023.
Now, what should auto dealers expect for the second part of the year? It would be an understatement to say that the current situation is confusing for Canadian business owners. With the Bank of Canada doubling down on its approach while the economy is still showing clear signs of dynamism, what will eventually prevail?
Well, Canada has yet to enter the period where interest rates start to have measurable effects on the economy. Historically, it takes 18 to 24 months for an economy to fully be affected by the interest rate hikes made previously by central banking institutions. Currently, our economy is 15 months removed from the initial target rate hike. This points towards Q4 as the period where significant changes in consumption patterns could occur and thus inform business owners of what’s to come.
In other words, it is more than likely that the expected economic downturn has been delayed, not avoided. Even the BoC’s own data seem to show that the overall demand excess might not be as important as portrayed. If we couple that with the increasingly higher debt levels among households, it is once again fair to assume that we are currently only observing the tip of the iceberg.
Also, one key aspect of the central bank messaging has changed since the last public announcement: there was a mention of corporate behaviour as a possible force behind the increase in prices. While this can look benign for afar, it could have a rippling effect on how consumers interact with vehicle dealers.
Auto dealers have been fighting tooth and nail to build environments of trust, transparency and clear communications with both potential and current clients. On the other hand, sticky inflation and the increase in prices and goods have many consumers looking for culprits behind these tougher economic times.
Now with the Bank of Canada even mentioning the possibility of corporate interests driving prices, this narrative will simply become more prevalent. It will become increasingly important for dealers to be aware of this dynamic, be understanding of consumers and circle back to the basic customer service fundamentals that have helped auto dealers become some of the most reliable and trustworthy businesses in Canada.
SOURCE: 1. May 2023 Canadian Sales, Desrosiers Automotive Consultants, 2023.
