MNI BOC WATCH: More Gradual Approach Seen After 2nd 50BP Cut
Canada's central bank slashed borrowing costs by a half point for the second meeting in a row Wednesday and officials anticipate a more gradual approach from here as substantial policy relief flows into a weak economy, while noting "a major new uncertainty" from threatened U.S. tariffs.
The overnight rate fell to 3.25% as expected by 12 of 18 economists surveyed by MNI, while another six called for a 25bp move that echoed three decisions earlier this year. In general, economists see the key rate falling to about 2.5% by the middle of next year, a bit below the Bank’s estimated neutral rate.
"With the policy rate now substantially lower, we anticipate a more gradual approach to monetary policy if the economy evolves broadly as expected," Bank of Canada Governor Tiff Macklem said in an opening statement for a press conference due at 1030am EST. "Monetary policy no longer needs to be clearly in restrictive territory. We want to see growth pick up to absorb the unused capacity in the economy to keep inflation close to 2%."
While inflation is forecast to average about 2% over the next few years the outlook is now being buffeted by other policy shifts such as Canada's move to lower immigration targets that will weigh further on growth already missing the Bank's October projection. It's unclear whether Donald Trump's threat of 25% tariffs on Canadian products will implemented and in what form, the Bank said, stepping back from a deputy's earlier comments that tariffs posed two-sided risks to say now that "no one knows how this will play out."
Fiscal policy introduces another complication. The federal government's two-month sales tax holiday and other proposals to send cost-of-living relief checks to households means inflation will dip to around 1.5% in January from the latest reading of 2%. "The Bank will look through effects that are temporary and focus on underlying trends to guide its policy decisions," the Bank said, adding "measures of core inflation will help us assess the trend in CPI inflation." While left unsaid, Prime Minister Justin Trudeau could introduce a major budget deficit as he seeks to catch up in the polls before opposition parties force an election.
Macklem appears undeterred by opening up the biggest rate gap with the Federal Reserve in decades and CAD weakness. The gap has been a full percentage point this year and this 50bp cut takes the difference to 125bps, still half of a 1997 peak. The chief allusion to the currency trading around the weakest in several years lately was to say "the Canadian dollar has depreciated in the face of broad-based strength in the US dollar."
Weaker CAD is to be expected through a period of stronger U.S. growth fueled by deficits. Canada's economy lags further after accounting for record immigration that dragged down per-person output. Experts tell MNI that amounts to a hidden recession rather than a soft landing.
Consumers are at further risk with many borrowers' five-year mortgages resetting at costs that reflect most of the Bank's prior hikes to 5% from near zero. That makes rising unemployment more of a danger, and consumption is already seen as the key risk to the official forecast.
Inflation hotspots linger such as housing and wages growing 4% at a time when officials call that out of line with stagnant productivity. Core inflation also remains slightly above 2%.
While the Bank has led the G7 on cuts this year, out-sized moves remain unusual. Since the fixed announcement system began in 2000, the Bank hasn’t made multiple 50bp reductions outside of the pandemic, the global financial crisis or 2001 terrorist attacks.
The key rate is now at the top of the Bank’s estimated neutral rate of between 3.25% and 2.25%.
"Governing Council has reduced the policy rate substantially since June. Going forward, we will be evaluating the need for further reductions in the policy rate one decision at a time," the Bank's statement said.