Bank of Canada: After today’s cut, another one in September is likely

Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud. 

Bottom line

The Bank of Canada cut its policy rate to 4.50% and will continue quantitative tightening (QT), in line with our expectations.

The key message in today’s decision is that the Bank of Canada is leaning toward cutting its policy rate unless inflation surprises to the upside. Governor Macklem highlighted in its opening statement, “if inflation continues to ease broadly in line with our forecast, it is reasonable to expect further cuts in our policy interest rate” and added “the downside risks are taking on increased weight in our monetary policy deliberations.”

Moreover, it is also evident that the BoC is becoming more confident that inflation dynamics are consistent with the inflation target. As such, the central bank highlights that “the bank’s preferred measures of core inflation have been below 3% for several months and the breadth of price increases across components of the CPI is now near its historical norm”.

We had been expecting the BoC to consider a pause at the September meeting to better assess the impact of the recent rate cuts. However, based on what the BoC is saying, a rate cut in September is likely their default path, as long as the inflation dynamic and the breadth of inflationary pressures remain consistent with the inflation target.

Looking further ahead, Governor Macklem mentioned the need for stronger growth to close the slack in the economy but did pre-commit to further rate cuts, preferring to remain data-dependent. Nevertheless, additional policy easing after September should be expected and the policy rate is likely to end the year at 4.00%.

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 higher than pre-pandemic. This means that the extent of the rate cuts could be limited, meaning that interest rates a year from now are likely to be higher than pre-pandemic for a long period.

The BoC cuts its policy rate by 25bp to 4.50%, as we expected. It also said that it will continue its quantitative tightening policy. In its statement, the BoC notes that “price pressures continue to ease and inflation expected to move closer to 2%” and “ongoing excess supply is lowering inflationary pressures. However, the BoC also added that “price pressures in some important parts of the economy—notably shelter and some other services—are holding inflation up”.

While the Communiqué did not include any reference to the likelihood of further rate cuts, Governoe Macklem mentioned in his opening statement to the press conference that “If inflation continues to ease broadly in line with our forecast, it is reasonable to expect further cuts in our policy interest rate. The timing will depend on how we see these opposing forces playing out. In other words, we will be taking our monetary policy decisions one at a time.”

On balance, the BoC signals that it is leaning toward further cuts if inflation continues to behave in line with the inflation target.

The BoC sees the global economy “expanding at an annual rate of about 3% through 2026”, roughly unchanged from the April MPR. The US economy is slowing, as expected, with weaker consumer spending. On the flip side, growth improved in the Euro area after some weakness in 2023, while the Chinese economy is growing modestly, with with weak domestic demand partially offset by strong exports. The BoC notes that “global financial conditions have eased, with lower bond yields, buoyant equity prices, and robust corporate debt issuance”, while the Canadian dollar and oil prices have been relatively stable.

In the Canadian economy, the BoC notes that” growth likely picked up to about 1½% through the first half of this year” and “growth is forecast to increase in the second half of 2024 and through 2025”. However, the BoC notes that “with robust population growth of about 3%, the economy’s potential output is still growing faster than GDP, which means excess supply has increased”. Similarly, it also notes the slack in the labour market, as evidenced by the slowly rising unemployment rate.

The BoC downgraded its growth for 2024 to 1.2% from 1.5% and for 2025 to 2.1% from 2.2%. 2026 was revised higher to 2.4% from 1.9%. These new forecasts are above the current consensus of 1.0% for 2024 and 1.8% for 2025.

The BoC notes that “Bank’s preferred measures of core inflation have been below 3% for several months and the breadth of price increases across components of the CPI is now near its historical norm”. However, the BoC also acknowledge that shelter costs continue to be high. The central bank also notes that the breadth of inflation in the services remains elevated, especially in sectors closely affected by higher wages.