Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line.
The Bank of Canada cut its policy rate by 50bp to 3.75% and will continue quantitative tightening (QT), in line with our expectations. The key message in today’s decision remains that “If the economy evolves broadly in line with our latest forecast, we expect to reduce the policy rate further”, making it almost a certainty that another rate cut is very likely at the December meeting. However, the central bank is also very careful not to pre-commit to a rate path and make its next move dependent on incoming information and its impact on the inflation outlook. However, the mention that it sees the risks around its inflation forecast as “reasonably balanced” suggests that the central bank is not making a 50bp in December its default option but didn’t close the door to it either.
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% (see Faster cuts do not mean deeper cuts). 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 (see What happened to the recession? The role of the policy stance and demographics), 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.
As we expected, the BoC cuts its policy rate by 50bp to 3.75%. It also said that it will continue its balance normalization or quantitative tightening policy. The BoC adds, “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.” Moreover, Governor Macklem also added that “we view the risks around our inflation forecast as reasonably balanced”, with both upside and downside risks.
On balance, this signals that Bank of Canada will be gradually returning its policy rate to neutral over the next months but does not want to pre-commit to a path.
The BoC sees the global economy expanding by 3% over the next two years, with little change from the July Monetary Policy Report (MPR). However, the composition has changed somewhat, with the US economy expected to be stronger than previously forecast. At the same time, the Chinese economic prospects were somewhat lowered, and Europe’s growth is expected to remain modest. Global inflation has declined in recent months and is closer to central banks’ targets. The BoC notes, “Global financial conditions have eased since July, in part because of market expectations of lower policy interest rates.” The central bank also notes that the oil price is $10 lower than expected in the July MPR.
The BoC notes that the Canadian economy grew more modestly than expected in the July MPR and notes that, while overall consumprion is increasing, it is declining on a per capita basis. The Bank also mentions that “exports have been boosted by the opening of the Trans Mountain Expansion pipeline”. The Bank notes that the labour market remain soft and that rise in the unemployment rate is mainly due to job creation being weaker than the increase in the labour force.
The updated forecast contained in the October MPR has changed little from July, with growth expected to improve over the projection period thanks to lower interest rates. As the Bank points out, “This forecast largely reflects the net effect of a gradual pick up in consumer spending per person and slower population growth.” The lower interest rates are also expected to support housing demand and renovation activity. Similarly, lower rates will help business investment, a pick up in domestic demand and continued strong demand from the US.
The BoC “expects inflation to remain close to the target over the projection horizon, with the upward and downward pressures on inflation roughly balancing out”. The BoC expects the upward pressures on inflation from shelter costs and other services to diminish, while the downward pressures to inflation should diminish as the slack in the economy is absorbed. Importantly, the BoC adds “we view the risks around our inflation forecast as reasonably balanced.”
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Independent Opinion
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