Today’s reading on gross domestic product hasn’t settled the debate in money markets and among economists as to whether the Bank of Canada will cut its trend-setting interest rate by 25 or 50 basis points next month.
But for markets, the data were enough to give modestly better odds to the larger of the two possibilities at the Oct. 23 policy meeting - 52.3% to be precise. Prior to today’s GDP reading, markets were assigning a slightly better chance for a 25 basis point cut.
Several economists are also now suggesting a 50 basis point cut looms.
The U.S. also released a key inflation reading simultaneously that showed easing price pressures in the world’s largest economy, boosting the chances of an outsized interest rate cut at the Federal Reserve’s November meeting. That’s also providing the Bank of Canada with the room to cut its policy rate further without heightened risks of weakening the Canadian currency.
Canada’s GDP expanded at a faster-than-expected 0.2% rate in July, driven by growth in the retail trade and public sectors, Statistics Canada said on Friday. Preliminary data for August, however, showed GDP was essentially unchanged. That forecast puts the economy on track for 1% annualized growth in the third quarter if GDP remains unchanged in September. The Bank of Canada had predicted a 2.8% growth rate for the third quarter in July.
The central bank has cut interest rates three times since June, moving in quarter-percentage-point steps, but has said it could shift to larger cuts if the economy needs a boost.
Here’s how implied probabilities of future interest rate moves stand in swaps markets, according to LSEG data following today’s data release. 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. The second table to the bottom is a breakdown of probabilities for the size of a cut on Oct. 23.
And here’s how interest rate probabilities looked just prior to today’s decision:
Here’s how economists are reacting in written commentaries this morning:
Douglas Porter, chief economist, BMO Capital Markets
Canadian real GDP growth is tracking below 1.5% in Q3, below potential and even below the modest pace of the past year. This means that even further slack in opening up in the economy, which will eventually put more downward pressure on inflation. With headline CPI now already at the BoC’s 2% target, oil sagging deeply, and the jobless rate at 6.6% and rising, below-trend GDP growth is not a welcome development. Governor Macklem has stated that the Bank wants growth to pick up, and the trend does not seem to be cooperating, clearly raising the odds of more aggressive hikes—i.e., 50 bps in October.
Olivia Cross, North America economist, Capital Economics
Although the rise in GDP in July was stronger than expected, the preliminary estimate of unchanged GDP in August suggests that the momentum was short lived and puts third-quarter growth on track to surprise marginally to the downside of our already downbeat forecast of 1.2% annualised. With little sign that the economy is accelerating as the Bank of Canada had forecast, we expect that the Bank will cut interest rates by 50bp at its October meeting.
Royce Mendes, managing director and head of macro strategy at Desjardins Securities
The acceleration in the pace of overall economic growth in July came despite wildfires restricting activity in parts of the country. That said, the pickup appears to have been ephemeral, with the flash estimate for August once again showing no increase. Growth appears to be tracking just over 1% for Q3, well below the Bank of Canada’s 2.8% forecast. As a result, we see central bankers lowering rates by 50 basis points in October.
Katherine Judge, economist, CIBC Economics
Canada’s July and August advance GDP data was a win some, lose some situation. The 0.2% July reading was two ticks above the advance estimate, but in line with our forecast, yet the advance reading for August pointed to a stall in activity. With some of the lacklustre August performance tied to railway disruptions, September is poised to see a bounce back, but that would still leave GDP for the quarter as a whole tracking around half the pace that the BoC assumed in its last forecast for 2.8% annualized GDP. Our forecast assumes that the BoC will do a couple of 50bps cuts, in December and January, after cutting by 25bps in October, but the timing of the 50bps cuts could get moved up if the September employment data looks weak enough. ...
GDP growth in the third quarter is likely to be closer to 1 1/2%, which is well below the Bank of Canada’s forecast, as the economy isn’t seeing the lift expected from goods-producing industries. For the Bank of Canada’s October announcement, the upcoming employment report will be key in determining whether a 25bp or 50bp cut is necessary, with today’s data not enough to sway us from our 25bp call at this point.
Derek Holt, vice-president, Scotiabank Economics
I thought the overall tone and details behind the numbers were solid. Markets didn’t care one bit as Canada 2s rallied in lock-step with US 2s after US core PCE inflation undershot consensus by a tick (+0.1% m/m SA). USDCAD also shook it off. OIS markets continue to price just shy of a percentage point of rate cuts over the remaining two meetings this year which seems excessive to me absent a crisis. ...
Statscan’s August ‘flash’ guidance [was] that GDP was “essentially unchanged.” First, who cares, as their initial estimates have a lousy track record. ... Revisions are common and can often be quite large. Statscan had previously guided that July GDP was “essentially unchanged” and here we just got 0.2%.
Second, the wildfire hit to July could drive a rebound in August onward.
What we’re left with is a picture of an economy that is underperforming, but still growing in trend terms despite massive rate hikes in the pandemic and serial shocks being thrown at it. ...
The core debate in Canada lies around two tensions. Should the BoC upsize and swing into near panic mode because GDP growth is mild, underperforming, and adding to a fairly modest amount of spare capacity with an output gap estimated around just over –1%? Or should it be more patient, stick to its forecast rebound and be careful toward upside risks given massive pent-up savings and demand in the household sector plus ongoing fiscal stimulus that may increase into an election year plus mortgage finance easing and runaway real wage gains relative to weak productivity? I lean toward the latter. If the BoC leans toward the former and pursues rapid easing, then I would counsel raising growth and inflation forecasts and the potential resumption of hiking. Governor Macklem’s first half of his seven year mandate was a disaster. If he wants to redeem himself before his term is up in June 2027 then I think he should play the longer game.
Charles St-Arnaud, chief economist, Alberta Central
With inflation below the upper band of the inflation target of 3% for some months, the Bank of Canada has shifted its focus away from inflation to the downside risks to the economy. Moreover, recent comments from Governor Macklem suggest two things: 1) the door is wide open to a 50bp and the hurdle to make a bigger cut is not as high as we thought, and 2) the BoC could be considering bringing its policy rates towards neutral faster than we expected. With this in mind, we believe that the BoC is likely to decide to accelerate the removal of the monetary tightening and cut by 50bp in October. However, faster cuts will not necessarily translate into deeper cuts.
Nathan Janzen, assistant chief economist, Royal Bank of Canada
Slowing inflation has allowed the BoC to shift focus to downside economic growth risks - with Governor Macklem reiterating after cutting the overnight rate earlier this month the need to " increasingly guard against the risk that the economy is too weak and inflation falls too much.” Even with a tick higher in July, GDP is tracking another per-capita decline in Q3 and below the BoC’s prior forecast. The unemployment rate has continued to drift higher and inflation lower. The case for additional interest rate cuts against that backdrop is clear - we continue to expect further gradual interest rate reductions (at a 25 basis point per meeting pace) down towards a 3% overnight rate with risks tilted to larger/faster cuts should the economy deteriorate significantly further.
Bryan Yu, chief economist, Central 1 credit union
While July’s GDP uptick was a surprise, the underlying economy remains soft. Statistics Canada’s preliminary estimate for another flat (but likely to be revised) performance in August points to Q3 GDP growth of about one per cent, which is below the Bank of Canada’s outlook while still running below population growth. Per capita GDP will deteriorate. With inflation returning to two per cent, the Bank of Canada has pivoted its focus towards the economy and labour market slack and potential downside risks to inflation. Today’s GDP print will keep the Bank on its rate cutting path. We still expect the Bank to cut by 25 basis point increments through the end of the year and to 2.75 per cent by mid-2025. That said, cuts could come faster and larger increments if the economy deteriorates more quickly.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank Financial
While consumers saved the day in July, we shouldn’t expect too much from them over the coming months. Despite the interest rate cuts, many households will experience interest payment shocks and be forced to cut back on their spending. What’s more, a number of indicators do not bode well for hiring in the months ahead. Job vacancy rates in the private sector are plummeting and fewer and fewer SMEs are experiencing labour shortages, as more than half of them are now focusing on sales. Another recent development to keep an eye on is the fact that the number of active businesses crashed in June, posting a contraction of 1%, the first time this has happened since the worst months of the pandemic in 2020. In such an environment, we expect growth to remain sluggish over the coming months.
With files from Reuters