BoC expected to deliver another bumper size cut, despite currency concerns
The Bank of Canada is expected to deliver another oversized interest-rate cut on Wednesday, although policy makers will have to weigh the need for economic stimulus against the risk of a weaker loonie.
Central bank officials have been clear that they intend to keep lowering interest rates now that inflation is largely under control. The question, after four consecutive rate cuts, is how fast to keep moving.
Until recently, financial markets expected the bank to shift back to a normal quarter-point rate cut on Dec. 11, after a half-percentage-point move in October. However, a run of weak economic data – capped by a jump in the unemployment rate in the latest jobs numbers, published Friday – has led most analysts and investors to pencil in another oversized move for this week’s decision.
Interest-rate swap markets, which capture expectations about monetary policy, put the odds of a 50-basis-point cut at around 85 per cent, according to LSEG data (a basis-point is 1/100th of a percentage point). Twenty-one out of 27 analysts polled by Reuters, including economists at Canada’s six big banks, also expect a half-point move.
The case for another big cut, which would bring the policy rate to 3.25 per cent from 3.75 per cent, looks compelling.
Annual Consumer Price Index inflation was bang on the central bank’s 2-per-cent target in October, and has been within the bank’s control range all year. GDP growth, meanwhile, undershot the bank’s forecast in the third quarter, and the unemployment rate jumped to 6.8 per cent in November from 6.5 per cent the previous month. That’s the highest jobless rate outside of the pandemic since January, 2017.
“Essentially it looks like inflation is back under control, the economy is much softer and the trend has been continuing to soften, and yet we still have a restrictive level of interest rates with the overnight rate still historically high,” Nathan Janzen, assistant chief economist at Royal Bank of Canada, said in an interview.
Bank of Canada Governor Tiff Macklem has said he wants to see economic activity pick up to absorb slack in the economy and prevent inflation from settling below 2 per cent. That dovish message suggests a preference for getting interest rates down quickly. The threat of U.S. tariffs following Donald Trump’s election may strengthen that conviction.
There are, nonetheless, risks to delivering a second half-point rate cut. Chief among these is the Canadian dollar, which is trading at a four-year low of around 70.6 cents against the U.S. dollar.
The weak exchange rate is partly the inverse of a strong U.S. dollar, which has been supercharged by Mr. Trump’s election on a pro-growth and pro-inflation platform.
It is also the result of the divergence between Canadian and American interest rates, with the U.S. Federal Reserve easing monetary policy more slowly than the BoC in response to stronger economic growth and stickier inflation south of the border. A 50-basis-point cut would put more daylight between the BoC and the Fed and send the Canadian dollar lower.
“While the move in the currency over the past number of months has been relatively orderly … you run a risk of the currency really weakening at a much faster pace that makes policy makers uncomfortable,” Benjamin Reitzes, managing director of Canadian rates at Bank of Montreal, said in an interview.
Mr. Reitzes said he expects the Bank of Canada to lean into the latest jobs data and cut by 50 basis points. But that doesn’t make it the right move, given the currency risks, he said.
“As the currency weakens, especially in the winter months, it will be detrimental to Canadians in general who have to pay higher prices for food and gasoline and other things that are imported, and that’s not a positive for Canadian living standards,” Mr. Reitzes said.
Recent economic data is also not as clear-cut as it might seem, said Royce Mendes, head of macro strategy at Desjardins, who has maintained his forecast for a 25-basis-point cut.
Economic growth was weaker than the Bank of Canada expected in the third quarter, but consumer spending grew at a robust annualized rate of 3.5 per cent. Housing market activity is picking up and measures of core inflation surprised to the upside in October.
Meanwhile, the sharp rise in unemployment last month was the result of a jump in labour force participation, not layoffs. The economy added a healthy 50,500 jobs, but this fell short of the blistering pace of population growth.
Mr. Mendes said the data are more “lukewarm” than bad. “It’s hardly convincing evidence that you need to absolutely cut rates by another 50. And just to put that in context, two consecutive 50 basis point cuts, when neither the Canadian nor the U.S. economy is in free fall, would be unprecedented,” he said in an interview.
“If central bankers are truly taking a risk management approach to decision making, then they need to consider the consequences of making a policy error,” he added, pointing to the risk of getting too far apart from the Federal Reserve and cratering the loonie.
If the Bank of Canada does meet market expectations and cut by 50 basis points, that would bring the policy rate to the top end of the bank’s estimate of the “neutral” range – an interest-rate level that neither restrains nor stimulates economic growth.
This article was first reported by The Globe and Mail
