The Bottom Line:
- As expected, the Bank of Canada (BoC) cut the overnight rate by another 50 bps to 3.25% on Wednesday, right to the top end of the BoC’s “neutral” range estimate (2.25% – 3.25%).
- Macklem’s opening statement made clear that with interest rates no longer “clearly in restrictive territory,”, the central bank will take “a more gradual approach” to monetary policy adjustments moving forward. That’s in line with our own forecast that expects the BoC will downshift to 25-bps reductions in their future meetings in 2025.
- We continue to expect that a weak economy will push the BoC to cut the overnight rate all the ways down to a stimulative 2%.
The Details (meeting recap):
- Today’s 50-bps cut was the second consecutive larger than “usual” reduction after the 50bp reduction in October and a string of earlier, smaller 25 bp cuts that started in June. The overnight rate has now been reduced by 175 bps in total.
- The acceleration in rate cuts came amid growing signs of persistent softening in economic activities and labour market conditions – GDP growth undershot the BoC’s forecast in Q3 and looks poised to undershoot again in Q4. The unemployment rate in Canada at 6.8% in November has risen by 1% since last year, or 2% since July 2022 when conditions were overheating.
- Overall, a soft domestic backdrop suggests the future path for inflation in Canada is still more likely lower rather than higher. A couple of things however are clouding that outlook.
- For one, the pace of immigration is set to slow sharply in 2025 and 2026, underpinning expectations that population growth in Canada will grind to a halt for the first time on record. The BoC in their statement expects slower growth as a result, but “muted” impact on inflation as lower immigration hampers both demand and supply in the economy.
- The possibility of trade disruptions was also mentioned as “a major new uncertainty”, although comments around that were fairly vague (rightly so) given enormous uncertainties associated with possible scenarios.
- Finally, the GST tax holiday scheduled to start mid-December and end by mid-February got an honorable mention. It will mechanically bias the headline inflation readings lower (as CPI prices include indirect taxes), but could actually work to increase underlying price growth by stimulating demand.
- The BoC suggested to look at the core measures (CPI trim, median) instead, that strip out related effects and should offer a better gauge of inflation pressures during those months.
- Circling back to the growth backdrop, in Q3 there were already tentative signs that economic activities, especially those that are interest-rate sensitive (consumer spending, housing) are picking up. Still, business spending was softer and there is still slack in the economy. Interest rate cuts will continue to work to stimulate activities, especially labour market, with a significant lag.
- We expect per-person GDP to remain soft in the near-term, and unemployment rate will keep edging higher before leveling out at round 7% early in 2025. Persistent softening in the economy into 2025 should ultimately motivate the Bank of Canada to cut rates down to stimulative territory, at 2%.
This article was originally published by RBC Economics. For more, visit rbc.com/economics.
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