Prime Minister Justin Trudeau’s suite of new fiscal spending measures aimed at helping to ease cost of living pressures have markets and some economists nearly ruling out a jumbo-sized rate cut by the Bank of Canada next month.
Ottawa announced Thursday a list of products that will be subject to a “GST holiday” until mid-February of next year. Those making under $150,000 annually will also be getting a $250 cheque in the mail. That extra fiscal stimulus, in theory, would provide a boost to the economy but also risk upward inflationary pressures – which the Bank of Canada would take note of in setting interest rates.
Markets have already taken note. Canadian bond yields Thursday moved up much quicker than their U.S. counterparts. The Canada 2-year bond yield – sensitive to central bank moves – was up 12 basis points by late afternoon, versus a rise of only 4 basis points for the U.S. two year. They more commonly trade nearly in sync. Bond yields tend to rise when traders anticipate inflationary pressures.
Overnight index swaps markets, which capture trading bets on future monetary policy moves, now suggest only about 10-per-cent odds of a 50-basis-point rate cut next month. That’s down from about 27-per-cent odds following Tuesday’s hotter-than-expected inflation report (they stood at 39 per cent prior to the consumer price data).
Markets are fully pricing in a move of some kind next month. But they are now only assuming about 75 basis points more in total monetary easing by the Bank of Canada until it reaches where the bank’s overnight rate will ultimately settle in this economic cycle – the so-called neutral, or terminal, rate. The Bank of Canada has estimated the neutral rate, where its policy rate settles when the economy is in equilibrium, to be somewhere between 2.25 per cent and 3.25 per cent.
Here’s how implied probabilities of future interest rate moves stood in swaps markets late afternoon Thursday, according to LSEG data. The overnight rate currently 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.
Bank of Montreal and Desjardins Securities issued notes Thursday afternoon suggesting a 50 basis point cut is now pretty much off the table.
Not all economists are ready for that call, however.
Katherine Judge, senior and senior economist with CIBC Capital Markets, said the bank is still expecting a 50-basis-point cut in December. “The GDP and employment data coming up will be more important for the call,” she said in an e-mail to The Globe and Mail.
Similarly, the base case of David Doyle, Macquarie’s head of economics, remains 50 basis points in December. However, he told the Globe through a spokesman, “it may make a 50 basis point cut in December less likely.”
Here’s the economist reaction so far in written commentaries:
Benjamin Reitzes, managing director, Canadian rates and macro strategist, BMO Capital Markets
The stimulus announced by Ottawa today is meaningful. The ~$6bn package is about 0.2% of GDP; and, with Ontario already sending about $3 bn in stimulus cheques early in the new year, that puts total early 2025 stimulus at ~0.3% of GDP. ...
We’re assuming a good chunk of the stimulus cheques will be saved, but the GST/HST rebate will drive additional spending. BMO Economics is boosting Q1 GDP growth from 1.7% to 2.5%, with 2024Q4 and 2025Q2 seeing a smaller upward move, while Q3 was trimmed as the impact fades.
The inflation impact is likely temporary with a steep deceleration in headline CPI expected in December and January (since the GST/HST move starts/ends mid-month) and a re-acceleration in February/March. Lots of noise coming on headline inflation, and a touch likely for the cores as well.
For the Bank of Canada, the combination of the new stimulus, a more cautious Fed, upside inflation miss, along with an anticipated upward revision to GDP, should solidify expectations for a 25 bp rate cut in December, all but taking a 50 bp cut off the table. The Bank remains on a path to neutral, but there’s heightened uncertainty on where that is given the U.S. neutral rate is a significant input (and also very uncertain at the moment).
Government of Canada bonds have been on the defensive since CPI, and this announcement only reinforces that direction of travel. There’s room for further underperformance vs USTs, as the bearish case on the Canadian economy is fading.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
The total size of the combined package is estimated to be roughly $6.3 billion. That adds up to about 0.2% of GDP and could have a high fiscal multiplier, meaning it could translate into a noticeable boost to growth in the first half of next year. That said, the Bank of Canada will take this into account when considering how quickly and how far to cut rates. We continue to see a 25 basis point rate cut in December, with quarter-point cuts the norm in 2025, as the Bank of Canada carefully searches for a slightly stimulative policy stance. The announcement should all but close the door to a 50 basis point cut next month.
Taylor Schleich and Warren Lovely, economists at National Bank of Canada
In a vacuum, we wouldn’t expect these new measures to have a substantial impact on monetary policy decisions. After all, this amounts to less than 0.3% of GDP. Worthy of a slight growth upgrade to be sure but unlikely to have a significant or sustained inflation impact. However, the spending announcement does not come in isolation. Stimulus efforts are also underway at the provincial level too, Ontario readying a similar taxpayer ‘rebate’. Meanwhile, recent inflation data came in stronger than expected at the same as housing market activity accelerated and the unemployment rate stabilized (at least temporarily). We had argued that the size of the output gap warrants a rapid return to neutral (via a 50 bp cut in December) but for a central bank putting all its eggs in the data dependence basket, that’s become a harder sell. If the Bank, like the market, viewed the 25 bp vs. 50 bp rate cut debate as a coin toss back in October, recent developments may push them to 25 bps. But even if easing is more gradual in the near term, we’re not fundamentally recasting our Canadian outlook or our forecast of the terminal rate on what amounts to a modest, even if ill-timed spending announcement.