The Bottom Line:
- The BoC made the leap to cut the overnight rate by 50 bps today, amid accumulating evidence that the economy and labour markets are weakening by more than what is necessary to achieve the 2% inflation target.
- The reduction won’t be the last one. The level of the overnight rate is still restrictive at 3.75% and the BoC in the press release hinted at future rate cuts will follow to support a return to stronger GDP growth.
Impact to Our Forecasts:
-  We continue to expect one more 50-bps rate cut from the BoC this December to bring the overnight rate to the top end of the BoC’s estimate of its neutral range (3.25%) before a return to a more gradual pace of easing in 2025.
- Our base-case macroeconomic forecasts are weaker than the BoC’s. We think real GDP growth is more likely to stay subdued for longer in Canada as interest rates remain restrictive until 2025.
- We expect GDP growth of 1.3% in 2025, below the BoC’s projection of 2.1% and not meaningfully different from ~1% growth expected for this year.
- We also expect labour markets will continue to soften, with unemployment rate rising to 7% in the coming quarters and for softening activities combined to bring more disinflationary pressures in 2025.
- In terms of the terminal level of interest rates, we think BoC will cut to 2% by July next year, stimulative and a touch below the lower bound of the BoC’s own estimates of neutral rate at 2.25% – 3.25%.
The Details (meeting recap):
- BoC’s rate cut today was close to fully priced in in markets ahead of the meeting. Adding to odds of the 50-bps cut were the Q3 Business Outlook Survey and September’s inflation data last week, both pointed to lower present and future expected inflation in Canada.
- Governor Macklem led off his press conference saying that “we are back to low inflation” in Canada. Rather than focusing on a weak economy and the disinflation pressures that could follow, the BoC today highlighted balanced risks on inflation.
- On the upside, shelter and wage growth remain the main concerns but are both expected to slow. On the downside, a slower economic recovery (as we are anticipating) is “the biggest risk”.
- With the output gap still deeply negative (the BoC’s estimate was -0.75% to -1.75% in Q3) and monetary policy still restrictive, we think it’ll take longer for demand to rebound and excess supply in the economy to be absorbed.
- Rate cuts will boost the economy with a lag. Even with interest rates moving lower, many borrowers can continue to expect debt payments to go up in the years ahead. That speaks to more urgency to “front-load” the easing.
