BoC accelerates pace of rate cuts

By Claire Fan

The Bottom Line:

  • The BoC made the leap to cut the overnight rate by 50 bps today, amid accumulating evidence that the economy and labour markets are weakening by more than what is necessary to achieve the 2% inflation target.
  • The reduction won’t be the last one. The level of the overnight rate is still restrictive at 3.75% and the BoC in the press release hinted at future rate cuts will follow to support a return to stronger GDP growth.

Impact to Our Forecasts:

  • We continue to expect one more 50-bps rate cut from the BoC this December to bring the overnight rate to the top end of the BoC’s estimate of its neutral range (3.25%) before a return to a more gradual pace of easing in 2025.
  • Our base-case macroeconomic forecasts are weaker than the BoC’s. We think real GDP growth is more likely to stay subdued for longer in Canada as interest rates remain restrictive until 2025.
  • We expect GDP growth of 1.3% in 2025, below the BoC’s projection of 2.1% and not meaningfully different from ~1% growth expected for this year.
  • We also expect labour markets will continue to soften, with unemployment rate rising to 7% in the coming quarters and for softening activities combined to bring more disinflationary pressures in 2025.
  • In terms of the terminal level of interest rates, we think BoC will cut to 2% by July next year, stimulative and a touch below the lower bound of the BoC’s own estimates of neutral rate at 2.25% – 3.25%.

The Details (meeting recap):

  • BoC’s rate cut today was close to fully priced in in markets ahead of the meeting. Adding to odds of the 50-bps cut were the Q3 Business Outlook Survey and September’s inflation data last week, both pointed to lower present and future expected inflation in Canada.
  • Governor Macklem led off his press conference saying that “we are back to low inflation” in Canada. Rather than focusing on a weak economy and the disinflation pressures that could follow, the BoC today highlighted balanced risks on inflation.
  • On the upside, shelter and wage growth remain the main concerns but are both expected to slow. On the downside, a slower economic recovery (as we are anticipating) is “the biggest risk”.
  • With the output gap still deeply negative (the BoC’s estimate was -0.75% to -1.75% in Q3) and monetary policy still restrictive, we think it’ll take longer for demand to rebound and excess supply in the economy to be absorbed.
  • Rate cuts will boost the economy with a lag. Even with interest rates moving lower, many borrowers can continue to expect debt payments to go up in the years ahead. That speaks to more urgency to “front-load” the easing.

See previous versions:

By Claire Fan

  • The BoC lowered the overnight rate by 25 basis points for a third straight meeting, adding to cuts in each of June and July. The move was in line with market and our own expectations ahead of the announcement.
  • Governor Macklem’s opening statement for the press conference was again dovish, highlighting a shift in the central bank’s focus to a gradually weakening economy and for that to put further downward pressure on inflation. The BoC reiterated that it is “reasonable to expect further cuts” as long as those expectations are confirmed in the data.
  • Data to-date has been cooperating. As mentioned in the opening statement a slew of different inflation measures are all returning back closer to pre-pandemic “normal” levels. That puts Inflation concerns more and more on the back burner.
  • The BoC’s forecast in July was for core inflation (average of CPI trim and CPI median) to slow to 2.5% on a year-over-year basis in Q3. Latest in July, those measures were averaging at 2.6%.
  • Moving forward, as much as high inflation is not welcome by the central bank, below-target inflation is also a growing concern, speaking to rising downside risks to both the economy and inflation relative to the central bank’s latest forecast.
  • Indeed, the Canadian economy as the BoC indicated, remains in the state of excess supply in Q2 with the 2.1% quarterly annualized GDP growth once again falling short of potential GDP growth (estimated by the BoC at 2.4% for 2024) as surging population boosts the available labour supply.
  • Meantime, hiring demand in Canada has slowed and struggled to keep up with rising labour supply. That has led the BoC again to expect still-elevated wage growth (particularly relative to soft labour productivity growth numbers) will continue to moderate in the period ahead.

Bottom line:

The third straight interest rate cut in September from the BoC still leaves the overnight rate at relatively high (‘restrictive’) levels – particularly compared to a softening economic growth backdrop that’s expected to keep inflation on a downward trajectory. Despite some pockets of sticky price growth (shelter and “some” other services), the tone from the BoC has clearly shifted to worrying about a gradually but persistently weakening economy. Already, growth in the third quarter is looking to undershoot the BoC’s July forecast of 2.8%. We continue to expect the BoC to follow with another rate cut in October.

By Claire Fan

  • After a first interest rate cut in June, the Bank of Canada again lowered its key overnight rate by 25 basis points to 4.5%. The move was in line with market and our own expectations ahead of the announcement.
  • Governor Macklem’s opening statement for the press conference was more dovish than the rate announcement. The governor highlighted a reasonable expectation for future rate cuts should inflation continue to ease in line with BoC’s forecast. He also discussed the balance of risk to inflation, and highlighted an increase in weight to the downside.
  • On the downside, the BoC focused on the state of the Canadian economy, more specifically increased excess supply as indications that inflation pressures should continue to unwind.
  • Indeed, growth in the economy is expected to have decelerated again in the second quarter after slowing in Q1, leaving a bigger gap with potential GDP growth that’s still propped up by the rise in population. Although the BoC expects the government’s target on non-permanent residents should reduce population growth in 2025.
  • On the upside, the BoC highlighted several corners in the consumer basket that are still seeing elevated inflation, including shelter and other services (dining out at restaurants and personal care) that are labour heavy and therefore more closely affected by elevated wage growth.
  • On each of those pressure points there have been early evidence that inflation’s unwinding. Growth in rent prices especially in major markets appeared to have ground to a halt into the summer. CPI growth due to mortgage interest costs should slow naturally as interest rates decline. Finally, progressively weaker labour markets and businesses’ sentiment were all for wage growth to keep normalizing in the year ahead.
  • Moving forward and similar to our own forecast, the BoC expects unwinding in price pressures will persist and economic conditions in Canada will gradually improve. The BoC’s forecast is for their preferred core inflation measures to slow to 2.5% over the second half of 2024 from 2.7% in Q2, and slow further to reach the 2% target in 2025.

Bottom line:

The interest rate cut today from the Bank of Canada marks a continuation in the central bank’s effort to lower interest rates back towards “normal” levels, amid signs of slowing inflation. The BoC highlighted parts of the economy that are still seeing abnormally high pressure in price growth, but also thinks a weaker economic and labour market backdrop, as well as increased excess supply should continue to propel inflation back towards the target level this year and next. Against that backdrop, our expectation remains that there will be two additional rate cuts this year, one at each meeting after today’s meeting that will lower the overnight rate to a still restrictive 4% by the end of 2024.

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