Bank of Canada will have to `discover’ where neutral rate is, Macklem says

Governor Tiff Macklem offered more insight into the Bank of Canada’s decision to deliver a jumbo interest-rate cut last week, saying the easing makes sense given how aggressively it hiked borrowing costs to rein in price pressures in recent years.

 

Speaking at an event in Toronto hosted by technology publication The Logic on Monday, Macklem pushed back on suggestions that larger than quarter-point reductions in interest rates need only coincide with emergencies or times of economic stress.

 

“It makes sense to take some bigger-than-normal steps when you’ve taken some really big steps on the way up,” Macklem said. Beginning in March 2022, the central bank brought the benchmark overnight rate to 5% from 0.25% in less than a year and a half.

 

Macklem also said the central bank will have to “discover” the neutral rate — the theoretical level of borrowing costs that neither stimulate nor restrict the economy — as it eases monetary policy.

 

While policymakers estimate the range to be between 2.25% and 3.25%, Macklem reiterated that the conditions that would reveal an exact neutral rate require a situation where there are no shocks to the economy, inflation is at the 2% target and growth is near capacity, which he says “will never happen.”

 

The comments suggest that while officials are set on continuous reductions in borrowing costs, there’s no predetermined path, and they remain uncertain about exactly where interest rates are headed in Canada. It’s one of the first times Macklem has signaled that the central bank may end up searching for an endpoint as they normalize rates further.

“We don’t know exactly the pace. We don’t exactly know where the landing is,” Macklem said.

 

Traders in overnight swaps are betting the central bank brings the policy rate to about 3% by March 2025, but haven’t fully priced additional cuts after that meeting.

 

“It highlights how much broader uncertainty there is with respect to forecasting,” Benjamin Reitzes, rates and macro strategist at Bank of Montreal, said by email. “The US election, immigration changes, a potential Canadian federal election, and various provincial elections — there are many variables driving uncertainty for the outlook.”

 

Last week, policymakers cut the policy rate by 50 basis points to 3.75%. Easing by that amount doesn’t often happen in Canada when the central bank is bringing interest rates to more normal levels, and it typically coincides with recessions.

 

A sharp decline in economic growth in Canada isn’t the base case for the central bank nor most economists, but officials justified their decision to opt for a larger bout of easing by saying it was to “stick the soft landing.”

 

 

 

 

–With assistance from Curtis Heinzl.

This article was first reported by BNN Bloomberg