With the Fed having broken the 50bp taboo, the BoC has now followed suit. After trimming rates by 25bps at three consecutive meetings, the Bank of Canada has upped the easing pace, delivering a 50bp cut that takes the main policy rate to 3.75%.
That said, this acceleration had been widely expected by markets and matched our own expectations for this latest policy decision. More interesting, however, was the guidance that accompanied this rate announcement. At first glance, we are inclined to think that the BoC’s view of the Canadian economy remains overly optimistic.
As such, we see the balance of risks skewed toward data continuing to undershoot BoC forecasts, leaving us to look for a further 50bp reduction in rates at the December policy meeting.
Turning first to the headline decision, swap markets implied a roughly 80% chance that the Governing Council would cut rates by 50bps pre-announcement. Sell-side consensus, meanwhile, favoured such a move by a 2-1 ratio. Given this, markets were initially unperturbed by the headline 50bp cut.
As always, however, the devil is in the details, and we are inclined to see these as offering some dovish hints in context.
In terms of guidance, the Governing Council reiterated previous statements that further cuts would be delivered if the economy progresses as expected. But in doing so, the Bank is leaving the door open to another 50bp move. Specifically, the Governing Council noted 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.”
On this point, 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.
Author:
Nick Rees, Senior FX Market Analyst