The Bank of Canada on Wednesday cut its key policy rate by 25 basis points to 4.25% as expected, while expressing concern that weaker-than-anticipated growth might mean inflation falls too quickly.
Still, some economists said the tone of the bank’s statement was not quite as dovish as it could have been given recent weakness in the economy. And that sentiment is making money markets reluctant to price in rate cuts of more than 25 basis points at any future policy meeting.
The 25 basis point cut on Wednesday itself was well telegraphed ahead of time, and the market reaction reflected that. The Canadian dollar barely budged and Canada’s two-year bond yield was down about 3 basis points - about where it started the North American trading day and in line with the move in the equivalent U.S. Treasury.
However, the U.S. Labor Department released data shortly after the Bank of Canada decision that showed job openings in July were lower than expected and at the weakest level since the start of 2021. That put additional downward pressure on Canadian bond yields, though not as much as on their U.S. equivalents. The U.S. two-year yield by 1120 am was down by nearly 10 basis points - and the Canadian two-year yield was lower by about 5 basis points. The greenback turned weaker on that U.S. labour data, which helped propel the Canadian dollar above the 74 cents US level in late morning trading.
The next BoC meeting is on Oct. 23, and implied interest rate probabilities in swaps markets now suggest about a 92% chance of another quarter point cut at that time – and 8% odds of no move. Markets continue to price in very strong odds of a further quarter point cut at the following meeting too on Dec. 24.
By next April, money markets suggest the Bank of Canada overnight rate will sit at 3.25% - a full percentage point below where it now resides today. However, markets are placing very little odds that the bank will step in with a larger 50 basis point cut at any of its future meetings.
Here’s how implied probabilities of future interest rate moves stand in swaps markets, according to data from LSEG as of 1013 am ET. The overnight rate now resides at 4.25%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
And here’s how interest rate probabilities looked just prior to today’s decision:
Here’s how economists and market strategists are reacting:
Stephen Brown, deputy chief North America economist, Capital Economics
The tone of the communications was less dovish than we expected following the signs of a slowdown in GDP growth at the start of the third quarter, suggesting a relatively high bar to a larger 50bp cut at the next meeting in October.
The Bank’s decision to cut by another 25 bp, to take the policy rate to 4.25%, was expected by all 28 economists polled by Reuters. Markets were nonetheless pricing in a near-25% chance of a 50bp move ahead of the announcement, which was understandable given the recent weakness of the activity and labour market data. Despite that weakness, the tone of both the policy statement and Governor Tiff Macklem’s accompanying opening statement to the press conference were more or less the same as in July. The policy statement noted that “preliminary indicators suggest that economic activity was soft through June and July”, but wage growth “remains elevated relative to productivity” and “price increases in shelter and some other services are holding inflation up”. In the press conference opening statement, Macklem repeats that “it is reasonable to expect further cuts in our policy rate” and, similarly to in July, that “with inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much.”
That emphasis on the downside risks leaves the door open to a larger 50bp cut at some point, but the Bank probably needs to see more progress on core inflation before it seriously considers that option. The three-month annualised change in CPI-trim and CPI-median was still north of 2.5% in July, although it could fall sharply ahead of the October meeting if the soft monthly gain in July is a sign of things to come. For now, our assumption is that the Bank will continue to cut by 25bp at each meeting until the policy rate reaches 2.5% next year, but the risks lie in the direction of a more aggressive pace.
David Rosenberg, founder of Rosenberg Research
While there surely are more cuts to come, the tone of the press statement was less dovish than was the case back on July 24th . There were a few caveats, like wage growth remaining “elevated relative to productivity” and that beyond shelter, “inflation also remains elevated in some other services.” In fact, to that second point, the Bank noted for a second time that “price increases in shelter and some other services are holding inflation up.” All attempts here to keep the markets from getting too carried away with the extent of future interest rate relief. But that interest rate relief is still coming our way. Monetary policy cannot be geared to just a few segments of the pricing pie at a time when the inflation trend is clearly subsiding. Not every component of the CPI can really be expected to move in tandem, and the Bank should really be concerned mostly about the overall pace and the pressures on inflation, which are clearly subsiding and again were paid service too in the communiqué. ...
A recession seems like a forgone conclusion, which only an immigration-led +3.5% population growth boom in the past year has managed to camouflage. The fact that the press statement finished off with “Governing Council is carefully assessing these opposing forces on inflation” is just an act so that investors won’t think as the BoC continues to ease, that it is taking its eye off anything that could remotely be considered as inflationary. Actions speak louder than words, but the Bank with a price-stability mandate clearly felt the need to throw that line in. Words are still pretty powerful, mind you, and with the statement reading that “economic activity was soft through June and July” and “the labour market continues to slow, with little change in employment in recent months” surely is not the message from any central bank that rate cuts are over. The Canadian economy is on a very shaky foundation, as absent the population boom, the economy would be contracting at a -2.4% annual rate.
If you’re wondering where the final destination point on this interest rate journey is, consider this little ditty: “The share of components of the consumer price index growing above 3% is roughly at its historical norm.” The labour market has normalized and so have the inflation indicators. But the policy rate still has a long way to go even after these cumulative -75 basis points of cuts to date. What is “normal” for the overnight rate? Try 2.3% over the past five years, 1.6% over the past ten years, and 1.8% over the past twenty years. So, Mr. Macklem and crew, you still have a long way to go before the bottom in rates is in. There still is opportunity here in the bond market seeing as investors have priced in a terminal rate closer to 2.75%. As for the Canadian dollar — rallies are to be rented as the fundamental trend will weaken over time.
Nick Rees, senior forex market analyst, Money Canada (foreign exchange firm)
Although this latest messaging was in line with prior commentary when taken as a whole, we think there were two key takeaways of note from today’s decision. First, there appears to be little appetite for cutting faster than the current series of 25bp increments, albeit Macklem acknowledged discussion of such a move in the Governing Council’s deliberations. Second, the Governor also noted an increasing need to guard against inflation falling too much – a stronger statement than prior comments. Considering today’s communications, we continue to think that there remains a high bar for a 50bp cut. But equally, Macklem’s emphasis on downside inflation risks also raises the threshold for the Governing Council to pause. We continue to look for the Bank to deliver a further string of successive 25bp cuts. We also expect this to be amongst the most aggressive easing paths in the G10, leaving rate differentials to weigh on CAD in the short run, before improving growth supports a loonie recovery later this year and into 2025.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
To unlock the savings that households have built up, we think the Bank of Canada will need to continue cutting interest rates at each of its decision dates until at least the middle of next year. With growth faltering instead of picking up as officials had forecast back in July, the risk is that central bankers will need to slash rates in October by 50bps instead of 25bps to spur a recovery.
Government of Canada bond yields were relatively unchanged immediately following the publication, with the Bank of Canada’s communications not as dovish as they could have been given how weak the economy is performing relative to prior expectations.
Douglas Porter, chief economist, BMO Capital Markets
We expect the Bank to continue grinding down rates in coming meetings, and, while we anticipate a series of 25 bp steps into early next year, we certainly will not rule out a possible 50 bp step at some point. That’s especially true if CPI behaves and/or the unemployment rate takes another big step up. And the reality is that the jobless figures have quickly become equally as important as the inflation data in the Bank’s decision making. For now, we look for the Bank to cut rates to 3.5% by January, and then to 3.0% by next June, but the risks tilt to the Bank going faster than that, and potentially further.
James Orlando, director and senior economist, TD Economics
With inflation seemingly under control, the BoC can continue to cut rates as it focuses more on weakening trends in economic growth and the labour market. The unemployment rate has steadily moved higher over the last year, and layoffs are starting to take hold. And now that the central bank’s growth outlook for 2024 Q3 looks like a fantasy following last week’s GDP print, risks are mounting that the BoC is behind the curve.
Canadians should expect further rate cuts as the central bank’s policy stance is still at significantly restrictive levels. This is why we have another 175 bps in cuts cued up through next year. While the pace of cuts (25 bps per meeting) seems entrenched at the moment, the BoC has a long way to go to get monetary policy in line with the state of the economy.
Taylor Schleich and Warren Lovely, economists with National Bank Financial
With a 25 basis point rate cut all but assured, the focus of today’s decision was always going to be on the Bank’s guidance/stance. Overall, there was very little changed relative to July as Macklem reiterated it is still “reasonable” to expect further rate cuts (as long as inflation cooperates). At the margin, there appears to be a bit more confidence on the inflation outlook as shelter prices are seen as “starting to slow”. And as we got a sense of in July, they “increasingly” want to guard against too much slack and inflation undershooting over the projection horizon. What does it mean for the meetings ahead? To us, the BoC’s base case outlook is for continued 25 basis points cuts at each of the remaining meetings in 2024 (and likely well into 2025 too). However, there is a growing focus on downside inflation/economic risks which should keep markets pricing some probability of a larger-than-25 basis point cut. That’s appropriate in our view given the balance of risks in the labour market.
Tu Nguyen, economist with assurance, tax & consultancy firm RSM Canada
The Bank went so far as to indicate that more rate cuts are expected with ongoing disinflation.
We expect one more 25 basis point rate cut this year, ending 2024 at 4%. Furthermore, we expect rate cuts to continue into 2025 until the terminal rate is reached, which we estimate to be between 3% and 3.5%.
More disinflation is expected in the upcoming months as more households renew their mortgages at higher rates, thus needing to cut discretionary spending. The downside risk to growth has risen as high interest rate restrict consumer spending and business investments. In the last quarter, the economy expanded primarily thanks to government spending.
In addition, new restrictions on temporary residents – both international students and temporary workers – will put a lid on aggregate consumer spending. Over the past year, consumer spending per capita has declined as households tighten their purse strings, and aggregate spending only grew because of population growth via immigration. Now, with fewer immigrants coming in, the slack in the economy will become more apparent.
Charles St-Arnaud, chief economist, Alberta Central
Today’s decision doesn’t change our expectations for the policy rate. In our view, the BoC will cut its policy rate by 25bp at every meeting until it reaches the upper band of its estimate of the neutral rate, about 3.00%. This means cuts of 25bp in October, December, January, March and April. While an upside surprise to inflation could lead to a pause, we think the risk could be of an acceleration in the path of the cut, especially if the labour market were to falter. It is clear that the resilience of the labour market, especially layoffs remaining low, is a significant support to the economy and what will make the difference between a soft or a hard landing.
The focus should also be on the terminal rate in the easing cycle. As we have said repeatedly, the neutral rate is likely higher than pre-pandemic. This means that interest rates a year from now are likely to be higher than pre-pandemic for a long period.
Claire Fan, economist, Royal Bank of Canada
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 economic. 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.
Geoff Phipps, portfolio manager and trading strategist at Picton Mahoney Asset Management
The danger from here is that the BoC falls further behind the curve, with overly optimistic growth expectations embedded into policymaker thinking, despite weak GDP per capita, and jobs growth being driven by the lower productivity public sector.
The market is highly focused on the concentration of Canadian mortgage renewals over the upcoming 12-18 months that has the potential to severely weaken the consumer. Given the dovish shift in implied US policy, the BoC has “cover” for a more rapid pace of cuts than 25bps per meeting, which should be considered given a challenging growth and labour outlook.
Philip Petursson, chief investment strategist at IG Wealth Management
While it is not an explicit mandate for the BoC to support the labour market, it is entirely reasonable to expect the Bank to remain dovish on risks of further labour and economic weakness. We expect two more cuts of 25 bps each this year followed by additional cuts to a likely neutral rate of 2.5-3% by the end of 2025. All in all the Bank gave the market what it wanted - a clear path to lower rates.