MNI INTERVIEW: BOC To Slowly Cut To Neutral Over 2 Yrs- Stillo

The Bank of Canada will lower interest rates by about two percentage points back to neutral levels over the next two years, moving at about every other meeting to avoid another surprise burst of inflation, a former official from the country's largest province told MNI.

Weakness in the job market and overall economy will back Governor Tiff Macklem’s view that more cuts beyond June's opener will be required as inflation fades, according to Stillo, who correctly called the June move. But cutting only at every other meeting will be sufficient to stave off any deep slowdown, he said on MNI's FedSpeak podcast, adding that the BOC’s next decision on July 24 is likely to be a hold.

“When I read the tea leaves on what they are talking about, I think they are going to move cautiously,” said Stillo, former forecasting manager at Ontario’s finance ministry and now Canada Director at Oxford Economics. “It doesn’t mean they can’t cut in July but I think you will see them take intermittent pauses to assess how the housing market is doing. Wage growth is still above that sweet spot.” (See MNI INTERVIEW: BOC Likely To Hold In July, Save Firepower, Economist Says)

Officials have said they are watching wage growth and corporate pricing power to see if their view of slowing inflation is taking shape, and other experts have said cutting rates too fast could rekindle one of the world's most stretched housing markets. While housing has been tame in recent months, the last job report showed wage gains faster than 5%, which Stillo called a catch-up with the recent inflation surge. (See MNI INTERVIEW: Canada Housing Agency Sees Resale Price Boom)

ROOM TO DIVERGE

Headline inflation, which together with the core measure has come back within the Bank's 1% to 3% target band in recent months after peaking at around 8%, will probably return to the Bank's central 2% objective around the middle of next year, Stillo predicts. Canada's last inflation reading ticked up to 2.9% and there is a new report on Tuesday. “There are a lot of tailwinds still keeping inflation from coming right down to target soon,” Stillo said.

“They know that there was an overshoot of inflation, there was a credibility issue in the past and they want to proceed cautiously,” he said. The Bank will cut rates twice more this year, Stillo said, and return to a neutral rate he estimates at 2.75% by the middle of 2026. (MNI INTERVIEW: BOC To Skip Cuts At 2 Of 4 Meets This Year- ATB's Parsons)

Canada's dollar has been "fairly resilient" against the U.S. currency, according to Stillo, as the BOC cut to 4.75% while the Fed was still signaling no change to its rate of 5.25%-5.5%. Governor Macklem has said he's nowhere near the limit of how far borrowing costs can diverge. Stillo said “I don’t think he’s close to it but I think there is a limit, and I think he’s well aware of it,” while “the Bank has room to diverge a little more, but not beyond say a hundred basis points.”