Money markets are placing significantly higher bets on a Bank of Canada rate cut next week following a softer-than-expected Canadian GDP report this morning as well as a market-friendly inflation reading in the U.S.
Probabilities in swap markets imply just over an 80% chance of a quarter-point rate cut at the June 5 Bank of Canada policy meeting, up from about 66% odds prior to the 830 a.m. ET data. Those odds were only at about 60% earlier this week. Bond yields immediately fell after the data, with the Canada five-year government bond yield declining about 10 basis points.
The Canadian economy expanded at an annualized rate of 1.7% in the first quarter and real gross domestic product likely rose 0.3% on a monthly basis in April, data showed on Friday. The quarterly growth rate was slower than the 2.2% pace forecast by analysts in a Reuters poll, as well as the Bank of Canada’s 2.8% forecast. Fourth-quarter GDP growth was revised to an annualized rate of 0.1% from 1.0% reported initially.
The GDP report shows that Canada’s economy did not rebound from a soft patch last year as strongly as data initially suggested. Friday’s report is the last major data to be released ahead of the BoC’s interest rate announcement next week. In a Reuters survey conducted prior to Friday’s GDP report, three-quarters of 29 economists expected a 25 basis-point cut.
Meanwhile, the U.S. released its Personal Consumption Expenditures Price Index at the same time, which suggested progress on taming inflation. Core PCE, which excludes the volatile food and energy components, increased 0.2% last month against expectations of a 0.3% increase. Stock futures immediately turned green on the data.
The following table details how swaps markets are pricing in further moves in the Bank of Canada overnight rate, according to data from LSEG (formerly known as Refinitiv Eikon) minutes after the GDP figures were released. The current Bank of Canada overnight rate is 5 per cent. 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 markets were pricing in monetary policy changes just prior to the data being released:
Many economists and market strategists now believe the door is wide open for the Bank of Canada to cut interest rates next week. Here’s a snapshot of how they are reacting today:
Nathan Janzen, assistant chief economist, Royal Bank of Canada
The downside surprise in Canada’s Q1 GDP growth likely removes the last potential barrier preventing the BoC from easing off the monetary policy brakes with an interest rate cut next week. The economic data still hasn’t deteriorated in a way that is forcing urgent BoC action, but a slow bleed over the last 2 years has left per-capita output back at 2016 levels (and little-changed from a decade ago), the unemployment rate is up a percent from a year ago, and month-over-month increases in the BoC’s preferred inflation measures are running below the central bank’s 2% inflation target. Given that backdrop, there is little reason for the Bank of Canada to wait longer to begin at least a gradual easing cycle and continue to look for a 25 basis point cut to the overnight rate next week. ... We expect that, ultimately, a softer economy will keep inflation pressures moving lower in Canada. Contingent on that outlook, we look for 100 basis points of interest rate cuts this year that will leave the overnight rate at a still restrictive 4% by the end of 2024.
Royce Mendes, managing director and head of macro strategy at Desjardins Securities
Once again the Canadian economy is coming up short. The 1.7% pace of growth in Q1 undershot consensus expectations for an increase of 2.2% and the Bank of Canada’s prediction of 2.8%. The miss, however, came from the volatile inventories category. As a result, final domestic demand, a better gauge of underlying momentum, still advanced a heady 2.9% in the first quarter. That’s obviously better news than in previous quarters, but is being aided by the growing population. ....
Revisions wiped out growth previously seen in Q4 2023. After originally saying the economy grew 1.0% in the final trimester of last year, StatCan now believes the economy posted a meagre 0.1% advance. That said, final domestic demand was actually revised higher from -0.7% to 0.0%. That’s still uninspiring, but is at odds with the downward revision to the headline which came largely as a result of weaker inventory accumulation.
The flash estimate for April GDP showed an advance of 0.3% after a flat reading for March. The rebound, however, is likely in part due to the resumption of activity in the auto manufacturing sector after retooling-related shutdowns in March. As a result, don’t expect the economy to maintain April’s growth rate through the rest of the second quarter. Our team is tracking growth of between 1.5% and 2.0% for Q2, in line with the Bank of Canada’s 1.5% forecast.
Although the headline numbers likely overstate the weakness in Canada’s economy, today’s data confirm that the Bank of Canada needs to cut rates next week. With inflation cooperating, we expect Canadian central bankers to begin a rate cutting cycle on June 5th.
Douglas Porter, chief economist, BMO Capital Markets
Looking through all the monthly and quarterly wobbles, the big picture is that Canada’s economy has expanded by a meagre 0.5% in the past year. While the downside surprise in Q1 was driven by a big cut in business inventories, the reality is that underlying growth remains well short of potential, and slack is building for the overall economy. For the Bank of Canada, we believe the main message is that the output gap is widening, as reinforced by a less-tight job market, modestly increasing the chances of a rate cut next week. There are respectable arguments on both sides of the decision, but we believe the balance of evidence points to a cut—we’ve been calling for a June cut since late last year, and will stand by that call.
Olivia Cross, North America economist, Capital Economics
The 1.7% annualised gain in GDP in the first quarter was weaker than the Bank of Canada’s forecast for an above-potential 2.8% increase. With consumption growth looking much stronger than expected, however, we don’t think this enough to push the Bank of Canada to cut interest rates at its June meeting next week, rather than waiting until July.
Admittedly, growth in the fourth quarter was also revised sharply, from 1.0% annualised to just 0.1%. However, after all the revisions to previous data are accounted for, the level of GDP in the fourth quarter was a bit higher than before. Despite the downside surprise in the first quarter, the details look positive. Most of the miss was due to a drag from slower inventory building, which subtracted 2%-pts from GDP growth. Household consumption growth remained surprisingly strong given the weaker retail sales data, rising by 3.0% annualised in the first quarter, from an upwardly revised 3.2% in the fourth. We had expected government consumption to drive much of the growth in the first quarter, thanks to the end of the public sector workers’ strikes at the end of 2023. However, government consumption grew by a reasonably modest 2.1% annualised. Business investment rebounded by 3.1% annualised, which StatsCan noted was drive by increased investment in the oil & gas sector, presumably as producers geared up for the opening of the Trans Mountain Pipeline expansion.
The preliminary estimate of the monthly GDP data suggested that GDP rose by 0.3% m/m in April, which would put GDP on track to slightly outperform both our and the Bank of Canada’s forecasts for growth of 1.5% annualised in the second quarter.
Simon Harvey, Head of FX Analysis, Monex Canada (a foreign exchange firm)
Today’s Q1 GDP report has just killed the economic reacceleration argument in favour of the Bank of Canada holding rates next week. Not only did first quarter growth undershoot the BoC’s forecasts of both actual and potential growth, but it has done so against a much weaker base as Q4 GDP growth was revised significantly lower, dropping from an annualised rate of 1%, to just 0.1%. Moreover, the strong economic momentum visible at the start of the year following the end of public sector strikes has progressively dwindled as the months have progressed, with the economy ultimately flatlining at the end of the quarter. Today’s GDP report effectively confirms our long-held view that the Canadian economy remains cyclically weak, especially in the context of population growth running at around 3% per annum. Given that this is now signalled across all economic indicators, especially since April’s BoC meeting, we see no reason for the BoC to not cut rates next week. Moreover, based on the underlying trend in the data, we think there is a considerable risk that the BoC needs to embark on back-to-back rate cuts over summer, unless April’s anomalous surge in employment is a sign of an imminent improvement in economic momentum. We doubt that is the case, and as such continue to look for at least two rate cuts from the BoC over their next three meetings and crucially before the Fed meets in September, where we expect the FOMC to deliver their first cut. Failure to do so risks maintaining an overly restrictive policy stance for too long, resulting in a more aggressive easing cycle into year-end. Our dovish outlook for the BoC and Canadian rates reinforces our bearish stance on CAD. That said, owing to the more sympathetic external environment for risk, we have marked down our 3-month USDCAD forecast from 1.40 to 1.38.
On the whole, the undershoot in Q1 GDP data confirms that the Canadian economy is operating with excess slack, meaning that the renewed disinflationary progress since the start of the year should persist moving forward. Seeing as the Bank of Canada was looking for just that back in April before starting to ease policy, we see no reason for the BoC to hold rates next week. While one can never be completely sure with the Bank of Canada, given the Governing Council’s proclivity to move the goalposts at the last minute, we think it would be detrimental to their credibility to hold rates at current levels, leading many to assume that their policymaking is dominated by Fed policy. In either case, we suspect that next week’s decision should prove bearish for the Canadian dollar.
Derek Holt, vice-president, Scotiabank Economics
Markets didn’t spend any time looking beneath the GDP headlines while piling into the Canadian front-end and driving yields lower. They should have. I view the numbers as very constructive for several reasons not least of which that growth in consumer spending is at its strongest in years and needs no help from rate cuts. .... It’s my belief that the BoC will look more constructively on the overall set of numbers we just received than markets did. .... Key is that Final Domestic Demand (FDD) was up by 2.9% q/q SAAR in Q1. This is a cleaner, more distortion-free assessment of the underlying momentum in the domestic economy that removes inventory and net trade effects on growth and boils things down to what more directly applies to the BoC’s ability to steer the economy. That was the strongest growth in final domestic demand that Canada has seen since 2022Q1. Two years folks. When FDD performs like it just did, the BoC usually statement-codifies it as an offset to the mild Q1 GDP headline.
Tu Nguyen, economist with assurance, tax & consultancy firm RSM Canada
Canada’s GDP data add to the mountain of evidence that a rate cut should come next week. The weaker-than-expected report reveals an economy with little steam left. The lack of growth was even more pronounced since the base number of previous quarter’s GDP was also revised down.
Consumer spending on services rose, but mainly due to higher rents – an essential component that cannot be eliminated even as households tighten their budgets. Businesses are delaying investments until the rate environment improves. And the economy needs business investments to recover. Construction had come to a standstill and will do so until rates come down, allowing developers to carry out projects.
Now, the Bank of Canada might opt to wait another month, given April’s strong job report and wage growth, but that would keep the policy unnecessarily restrictive. Even with multiple rate cuts this year, the real interest rate will remain restrictive enough to restore price stability.
Matthieu Arseneau and Alexandra Ducharme, economists with National Bank
GDP was well below population growth at 3.0% (and thus below potential growth), which means to us that the economy continues to cool. To illustrate the counter-performance of the quarter, we need only look at GDP per capita, which continued its downward trend during the quarter and is now 3.5% below the peak recorded at the beginning of rate hikes. A decline of this magnitude has never been seen outside of a recession. This underperformance of GDP per capita has been reflected in the labour market, as evidenced by the unemployment rate, which has risen by three-tenths of a percentage point since December 2023. And there is cause for concern about the labour market in the months ahead, as output per worker has fallen sharply since 2022, illustrating a situation of overstaffing, while profits took a big hit in the quarter, falling 29% on an annualized basis. There are many other signs that the Canadian economy has cooled significantly, including significant progress in inflation in recent months. This progress is confirmed by another inflation measure released this morning. In fact, the consumption deflator shows inflation at an annualized rate of just 2.0% compared to last quarter, the lowest since the pandemic.
Let’s hope these developments will convince the central bank to cut interest rates this summer, as monetary policy remains extremely restrictive and risks doing too much damage to the economy in the coming months. This overly restrictive monetary policy is reflected in our gloomy economic outlook for the coming quarters and in a still rising unemployment rate (close to 7.0% by the end of the year).
James Orlando, director and senior economist, TD Economics
We have been arguing for months now that inflation dynamics have been justifying rate cuts, yet the BoC hasn’t signaled any intention to make a move. This central bank has prided itself on communicating its intentions to make changes to monetary policy ahead of an actual move. If it wants to keep up this effort of transparency and forward guidance, we expect the BoC will hold rates steady next week and use the meeting to tee-up a rate cut in July. That said, expect fireworks as the BoC could go either way with this one.
Katherine Judge, economist with CIBC
The Q1 figure was well below the Bank of Canada’s last published MPR forecast (2.8%), and activity looks even more sluggish when accounting for population growth, as the surge in domestic demand looks to be a one-off in the broader trend of weak readings seen last year. Policymakers are therefore on track to deliver the first dose of interest rate relief at next week’s meeting.
Charles St-Arnaud, chief economist, Alberta Central (credit union)
Today’s GDP number does not change our view for the Bank of Canada and continue to think the BoC will cut at its June meeting. Growth in Q1 was weaker than potential, suggesting further widening of the output gap.
With all measures of core inflation below 3%, the momentum in the BoC’s preferred measures below 2.5% and the breadth of the inflationary pressures in line with the historical average, all the conditions we had identified (see) to support a rate cut have been met. If the BoC doesn’t cut next week, it would be a matter of extreme caution in our view, rather than suggesting that upside risks to inflation remain a concern. Nevertheless, whether they cut in June or July has very little impact on the outlook. What matters more will be the speed and the number of cuts we will see over the next year.
Bryan Yu, chief economist, Central 1 (credit union)
Despite the mixed drivers in Q1, the softer GDP print was more than full point below the Bank of Canada’s outlook and should allow for a policy rate cut next week. A downward revision to Q1 points to an even weaker trend. The economy is still faltering on a per capita basis, inflation is under control, and risks from mortgage renewals are still in view. Firmer consumption growth numbers could trigger a hawkish tone from the Bank, and U.S. Fed policy will also factor into future moves. Nevertheless, we anticipate a 25 bps cut next week and a total of four cuts this year to bring the policy rate to 4.0% by year end.