Today’s Bank of Canada rate decision to cut its trend-setting overnight rate by a large 50 basis points didn’t take markets by much surprise. The two-year bond yield, which is particularly sensitive to changes in the Bank of Canada overnight rate, briefly fell a couple of basis points on the news, but remains hovering just above 3% and little changed for today’s session.
The Canadian dollar ticked slightly lower and is re-testing its lowest levels since the start of August. Just before noon ET, it was trading at 72.18 cents US. That’s still comfortably above key support at about 72 cents US, a level it has been trading above ever since the initial 2020 pandemic shock to markets.
Live updates: Bank of Canada delivers half-point cut, bringing key interest rate to 3.75%
Now the big debate becomes whether the Bank of Canada will do another 50 basis point cut at its next meeting on Dec. 11, or stick to a more traditional 25 basis point reduction. Money markets, for now, are heavily favouring a more traditional 25 basis point cut, by about 94 per cent odds. Trading in swaps markets also still suggests the overnight rate will reach close to 2.5 per cent by the end of next year.
Here’s how implied probabilities of future interest rate moves stood in swaps markets following today’s decision, according to LSEG data. The overnight rate now resides at 3.75 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.
The second table to the bottom is a breakdown of probabilities for the size of a cut on Dec. 11.
Here’s how economists and market strategists are reacting:
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
The tone of the suite of communications sounded just dovish enough to justify the aggressive action. Both GDP and inflation projections were downgraded for 2024, largely due to domestic demand and global commodity prices. The forecast for US growth was a bright spot, with recent revisions and dataflow supporting the upgrade. Looking ahead, the Bank of Canada still sees a solid rebound in GDP in 2025. That reflects the central bank’s confidence that consumption per person will pick up as monetary easing flows through the economy. The projections continue to doubt the federal government’s ability to aggressively curtail immigration, which is seemingly a key downside risk to these forecasts.
Policymakers didn’t seem eager to signal another 50 basis point move in December. While the official statement reiterated that rates are likely to fall further, it once again warned that the timing and pace of further reductions are uncertain. We don’t yet see the necessary ingredients for a follow-up jumbo-sized cut. With the level of rates starting from a now lower level and the American economy on stronger footing, the Bank of Canada might want to return to 25 basis point moves as it assesses the impact of recent monetary easing. Keep in mind, that new mortgage rules, meant to stimulate the struggling housing market, are also set to be implemented in mid-December, potentially adding to the reasons for a touch more caution.
Our longstanding view that the Bank of Canada will cut its policy rate down to a trough of 2.25% remains intact, but it’s no longer the most dovish forecast amongst economists. We believe that the Bank of Canada is correct to sound a bit more patient now that the policy rate of 3.75% is not as far above some estimates of the neutral setting.
James Orlando, director and senior economist, TD Economics
Now that headline CPI inflation has dropped below the 2% target, the BoC has gained confidence that it can cut rates at a quicker pace. While there isn’t much in the way of a changing economic narrative - slow GDP growth and core inflation above 2% remain - the central bank is set on doing what it can to boost economic growth. Will a 50 bp move achieve this? Probably not, but the central bank felt it should do something with economic data continuing to show that the country is stuck in a rut. Hopefully we get a bit more clarity on this in the press conference.
This won’t be the end of rate cuts. Even with the succession of policy cuts since June, rates are still way too high given the state of the economy. To bring rates into better balance, we have another 150 bps in cuts penciled in through 2025. So while the pace of cuts going forward is now highly uncertain, the direction for rates is firmly downwards.
Douglas Porter, chief economist, BMO Capital Markets
Perhaps the most striking feature of the Bank’s latest set of quarterly forecasts is how little they changed since July. For example, even with a big miss in Q3 GDP growth (1.5% instead of 2.8%), the full-year estimates have not budged for either 2024 or 2025, since surrounding quarters have been lifted. The Bank did trim the 2026 view by a tick, but that’s far down the line and a minor move. Their call on headline inflation has been shaved, by a tick this year and two next, but the two-year view on core has not budged (a one-tick trim for this year on Q4/Q4 basis, offset by a one-tick hike to 2025). Given the relatively modest adjustment in the bigger picture outlook on the economy, this forecast hardly calls out for urgency for additional large rate cuts.
Today’s outsized rate cut is mostly a response to the heavy-duty decline in headline inflation in the past few months. However, the underlying forecast and the Bank’s mild tone suggest that the future default moves will be 25 bp steps, unless growth and/or inflation surprise again to the downside. We certainly can’t rule that out, and our calls on both GDP and CPI are slightly lighter than the Bank’s, so there is still a risk of another 50 bp step at some point. For now, we will maintain our call of a series of five more 25 bp trims, taking the overnight rate to 2.5% by next June, at the low end of the Bank’s 2.25%-to-3.25% range for neutral.
David Rosenberg, founder of Rosenberg Research
While the Bank is hinting that markets should not expect to see a steady diet of jumbo rate cuts and that future decisions will be made meeting-to-meeting as opposed to being on some pre-set path, the reality is that embedded in the BoC forecasts is lingering “excess supply” beyond 2025 and into 2026. When we model this situation out, it implies a peak unemployment rate of 8% this cycle (from 6.5% today and the 4.8% low posted in July 2022) and a 0% inflation rate (from 1.6% currently and light years away from the 8.1% cycle peak).
The path of future rate cuts may be open for debate. But the destination is not. Even after today’s 50 beeper, the policy rate is still 100 basis points north of where the Bank’s own mid-point estimate of neutral resides. A policy rate above the neutral rate is totally incongruent for an economy in a state of lingering excess supply. Such a condition augurs for a rate no higher than 2%, and quite possibly lower, considering that it was sitting at 1.75% in early 2020 before COVID-19 entered our lives and that was a period when there was no disinflationary output gap — a time when economic growth and inflation were far lower and unemployment far higher than is the case today.
A policy rate at that level should be consistent with a 10-year GoC yield of around 2.5%, so at the current 3.25% level, there is value left in the bond trade, especially after this latest U.S.-induced backup. And rallies in the Canadian dollar, when they do occur, should be sold into. We continue to see an eventual new range being established between C$1.40 and C$1.50.
Tu Nguyen, economist with assurance, tax & consultancy firm RSM Canada
The size of the December rate cut will depend on upcoming job and inflation data, but a 25 basis point cut remains our baseline. With the US economy outperforming expectations, it is unlikely that the Fed will continue with larger cuts. And as much as the Bank is independent from the Fed, deviating too far from the Fed risks causing the loonie to lose even more value.
We expect the policy rate to fall to 3.5% by the end of 2024 and return to a terminal rate of 2.75% by early 2025.
Claire Fan, economist, Royal Bank of Canada
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 about 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%.
Stephen Brown, deputy chief North America economist, Capital Economics
The weak economic backdrop means there is a strong case for the Bank of Canada to follow its larger 50bp cut today, which took the policy rate to 3.75%, with another 50bp move at the next meeting in December.
Our forecast for a 50bp cut was a non-consensus call when we made it but, in the end, the Bank’s decision to accelerate its loosening cycle came as little surprise, with markets pricing in more than a 90% chance of the move ahead of the decision. The accompanying policy statement highlighted that the decision reflected the fact that inflation is “now back around the 2% target”, while the economy “continues to be in excess supply” and the “labour market remains soft”. According to Governor Tiff Macklem’s opening statement to the press conference, Macklem will tell us shortly that “price pressures are no longer broad-based” and “we want to see growth strengthen”. Nonetheless, the Bank does not seem confident that growth is on the cusp of accelerating strongly. The new Monetary Policy Report shows that the Bank now shares our view that third-quarter GDP growth was below the economy’s potential, at 1.5%, and the Bank now expects only a modest pick-up to 2.0% in the fourth quarter, which would be in line with potential at best. As a result, the economy will remain in a position of excess supply well into 2025, which will continue to put downward pressure on inflation.
Accordingly, it seems unlikely to us that the 50bp cut today will be a one-off. The Bank seemed to leave the door open to another larger move although was non-committal, noting that “if the economy evolves broadly in line with our latest forecast, we expect to reduce the policy rate further. However, the timing and pace of further reductions in the policy rate will be guided by incoming information and our assessment of its implications for the inflation outlook.” With little sign that economic growth is accelerating fast enough to close the output gap, and assuming further encouraging CPI data releases, we continue to expect another 50bp cut from the Bank in December. That would take the policy rate to 3.25% by year-end, the top end of the Bank’s 2.25% to 3.25% neutral range estimate, after which we would expect the Bank to revert to 25bp cuts until the policy rate reaches 2.25% in mid-2025 - although the risks to that terminal rate forecast now seem to lie to the downside.
Taylor Schleich, Warren Lovely & Jocelyn Paquet, economists with National Bank Financial
There may have been some headline uncertainty going into this decision, but markets and economists were clearly leaning towards this outcome. It’s the right move in our view as it would have been difficult to justify continuing with the gradual approach (i.e., 25 bp cuts) in light of a softer inflation and growth backdrop. Rather than the output gap starting to close in Q3 like the BoC had previously expected, slack absorption will have to wait at least until the fourth quarter. And while that is the baseline outlook for the Bank, we feel we’re in for a repeat of the past three months, where growth continues to undershoot the BoC’s optimistic expectations. And to be clear, their updated economic projections do look very optimistic to us. Should our forecast for a continued sluggish economy materialize, a follow-on 50 basis point rate cut in December should be viewed as the overwhelmingly likely outcome. On the other hand, if the economy were to break out of its underperformance funk and GDP growth picked up in line with the Bank’s projections, a return to 25 bp cuts could be justified. The Bank will continue to let the data do the deciding. Big picture, we still argue that restrictive monetary policy is no longer warranted in Canada and policymakers should quickly return to a more neutral policy stance. Note that official BoC estimates peg the neutral rate as being between 2.25% and 3.25%. A 50 bp cut in December would bring the overnight target to the upper end of that range.
Avery Shenfeld, chief economist, CIBC Capital Markets
An outsized rate cut was a no-brainer, and the simple message from the Bank of Canada is that there’s more to come if events unfold as expected. Today’s 50 basis point cut brought the overnight rate to 3.75%, as was widely expected, and based on the logic offered to justify today’s decision, it would take a significant turn of events to stand in the way of another cut of that magnitude in December. That said, as has been its practice of late, the Bank has kept its options open by not signaling anything specific about the size of individual rate cuts ahead. The statement plants a victory flag in the battle against inflation, which is now definitively expected to run around the 2% target, with a couple of ticks shaved off the inflation forecasts ahead being the only major change in the Bank’s projections. Growth is slated to be a bit sluggish at 1¾% over the latter half of 2024, but it would need to pick up from the recent pace to hit the Bank’s call. While the Bank sees better times ahead in the next two years, with growth averaging 2.2%, that’s isn’t by any means ruling out further interest rate relief, as softer monetary conditions are cited as the driver for the improvement.
Jules Boudreau, senior economist, Mackenzie Investments
A picking up in the pace of rate cuts was paramount. The Canadian economy couldn’t withstand a 4.25% policy interest rate without weakening further. The labour market is in a recessionary state, and there’s a higher chance that inflation undershoots the 1% lower band than it overshoots the 3% upper bound over the coming months. ...
A 0.5% cut is a good start towards getting rates to a level where monetary policy begins boosting economic growth, but the Bank of Canada’s messaging is too cheery. The statement accompanying the decision claims that “the upward and downward pressures on inflation roughly balancing out”. It’s understandable that officials might be reticent to declare victory against inflation, given the post-Covid surge in prices that jeopardized the Bank of Canada’s credibility in the eyes Canadians. Plus, there are certainly inflationary risks in the longer term (energy transition, de-globalization). But over the next few quarters, risks are clearly to the downside. Not positioning for that reality could cause the Bank of Canada to err towards higher-than-optimal interest rates.
We expect the policy rate to decline to 2% in mid-2025. Getting there sooner, with successive 0.5% cuts, would lower the risk of a further deterioration in a struggling economy.
Philip Petursson, chief investment strategist, IG Wealth Management
In this era of central bank transparency, sometimes the Bank of Canada primes the market ahead of a policy move and sometimes the market primes the Bank of Canada. Today we saw the Bank of Canada give the market what it has been pricing in for the past few weeks, with a 50 bps cut. It was as expected, and for good reasons.
It has been the case for a couple of months now that the BoC’s fight against inflation has been won. With the most recent print of 1.6% the Bank needs to consider the risk of undershooting its inflation target. As such, a return of the overnight rate to neutral as soon as possible should be the objective. We believe the neutral rate will fall between 2.5% - 3.0%.
Rapid rate cuts become even more apparent when considering the massive mortgage cliff approaching in 2025 where approximately 25% of mortgages come due for renewal. Mortgage borrowers will have to make trade-offs – spend more on your mortgage might mean spending less elsewhere – that’s an economic headwind.
What does this mean for investors? As we have highlighted in the past, the Canadian dollar exchange rate to the US dollar is highly influenced by the difference in interest rates between the two countries. If we are correct and the Fed follows in November with only a 25 bps cut of its own, that puts our fair value on the Loonie in the range of US$0.70-72. We have already seen downward pressure on the Canadian dollar pushing it from 74 cents to just below 73 cents in the last few weeks. In our view, the greater probability is that it will continue to push lower, not higher - With the lower range being the more likely.
Depending on how the Canadian data rolls out in the next two months this may not be the last 50 bps cut the Bank makes.
Nick Rees, senior forex market analyst for Monex Canada
We see risks that incoming data will underwhelm relative to the Bank’s latest forecasts. Staff estimated that Q3 GDP growth was below potential at 1.5%, albeit expecting a modest pick-up to 2.0% in Q4. We think this is a stretch, but even taking these latest projections at face value, it would still imply the economy remaining in excess supply well into 2025. This would suggest further downward pressure on inflation which is already below target at 1.6% YoY. Moreover, while the Bank could point to their preferred core-median and core-trim measures of underlying price growth, these are only just above target at 2.3% and 2.4% respectively. As such, we see significant downside risks to the Bank’s claim that core inflation will gradually decline to 2% by Q4 2026.
Moreover, we expect rate cuts to now mechanically weigh on mortgage interest cost pressures, a factor that Bank staff flagged in the MPR as remaining elevated. Pass-through should also lead to falling rent pressures too. In short, the two CPI components that seem to be troubling the BoC are also those that look set to become less of a concern as the BoC cuts rates. As such, despite Macklem describing inflation forecast risks as reasonably balanced in his press conference, we beg to differ, seeing a growing likelihood that price growth undershoots BoC forecasts.
For now, markets are taking a steer from Macklem’s failure to commit explicitly to a follow-up 50bp dose of easing in December. As such, while USDCAD has spiked post-announcement, the run higher for the pair has been relatively contained. Even so, we expect a slow drip of weak data between now and the final policy meeting of the year, a scenario that should see market-implied easing bets accelerate, weighing on the loonie into year-end.
Charles St-Arnaud, chief economist, Alberta Central
Overall, the BoC continues to signal that the policy rate will be returning to neutral in the coming months, but the speed will depend on incoming data. More specifically, Governor Macklem referred directly to the Q3 national accounts, employment reports, and CPI as key releases for the December meeting. If data come in on the weaker, we could see a 50bp cut, but if incoming data is more robust, we’ll see smaller 25bp cuts. We still believe that the BoC should rapidly return the policy rate to a more neutral level of about 3.0%. With this in mind, we still believe that, given the weak dynamic in inflation, a 50bp cut in December would be warranted.
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.
Derek Holt, vice-president of Capital Markets Economics, Scotiabank
The Bank of Canada cut 50bps to take the policy rate to 3.75% and explicitly left the door open to further rate cuts with the size and pace to be determined by data and other developments. They also left balance sheet plans unchanged. Cumulative easing to date equals 125bps of cuts. Their actions met our expectations while leaving intact my views on the longer-run risks the BoC may be courting should rapid policy easing continue. ...
I’d say they pulled it off reasonably well today. They cut -50bps and kept everyone guessing with markets on the fence for the size of the next move with terminal still priced around 2.75–3% by next summer. ... I don’t have a view on the size of the next move in December at this point but I would not just assume that this is a one-and-done upsizing. Our published forecast implies a quarter-point move but isn’t worth much at this stage before we get a LOT of data between now and then.
Tiffany Wilding, economist, PIMCO
Rates may need to fall below the BoC’s estimated neutral rate range of 2.25%–3.25% in order to stave off a significant undershoot of its inflation target and further weakening of the economy. In the near-term we expect the BoC to remain data dependent and think another 50 bp rate cut will be on the table in December if data remains weak in the coming weeks.
Vinayak Seshasayee, portfolio manager, PIMCO
The BoC’s faster rate cutting cycle underscores the opportunity in Canadian fixed income. The Canadian economic backdrop suggests the Bank of Canada is likely to cut faster and deeper than the Federal Reserve. While there are limits to how far the two central banks are likely to diverge, in our view, BoC policymakers should have the confidence to respond resolutely to domestic conditions. If we see these monetary paths diverge, then spreads between Canadian and U.S. bonds are likely to become increasingly negative, while the Canadian dollar could come under further pressure, especially in the absence of any demand-driven rebound in oil prices.