The Bank of Canada reduced its policy rate by 50 basis points to 3.75 per cent on Wednesday as growth replaces inflation as the central bank’s primary economic concern.
After five consecutive quarters of declining per-capita gross domestic product growth, Canada’s sluggish economy suggests that the Bank of Canada should accelerate its rate cuts to return to neutral.
We expect the policy rate to fall to 3.5 per cent by the end of the year and return to a terminal rate of 2.75 per cent in the first half of next year.
The economy remains in excess supply. Although rate cuts will bring relief for households renewing their mortgages, restrictive rates are still stifling consumption.
September’s unexpectedly strong jobs report was an anomaly rather than a shift in the labour market. The trend is a lack of hiring and rising unemployment, especially among youths and newcomers, as workforce growth outpaces jobs growth. Employers are still waiting for rates to fall further.
Wage growth is easing after months of being above inflation. In addition, wage growth expectations have also fallen, especially among younger workers. a reflection of lower labour demand and hiring freezes.
Read more of RSM Canada’s insights on the economy and the middle market.
The Bank of Canada’s Business Outlook Survey shows cautious optimism among businesses, but that outlook is conditional on further rate cuts that will lower the cost of borrowing and enable hiring.
The risk now lies in inflation falling too far below 2 per cent, rather than rising above it. Disinflation is spreading. The consumer price index fell below the central bank’s target of 2 per cent to a low of 1.6 per cent in September. The central bank’s preferred measure of core inflation has fallen below 2.5 per cent.
Excluding mortgage interest payments, inflation stands at 1 per cent. Since interest payments play a nontrivial role in driving inflation, rate cuts will further lower interest payments and inflation.
Inflation is a case where expectations drive reality. Since inflation expectations are down among consumers and businesses, inflation will continue easing.
Coupled with falling inflation expectations is the declining price of oil, which adds to disinflationary forces.
The takeaway
The Bank of Canada is likely to continue cutting rates in December, but the size of the reduction will depend on upcoming job and inflation data. A cut of 25 basis points remains our baseline.
With the U.S. economy outperforming expectations, it is unlikely that the Federal Reserve will continue with larger cuts. And as much as the Bank of Canada is independent from the Fed, deviating too far from the Fed risks causing the loonie to lose even more value.
