Ca reaction: BoC cuts again, no more Mr Gradual?

The Bank of Canada cut its main policy rate by 0.25% again in July, reducing it to 4.50% (with Bank Rate cut to 4.75%). This was in line with our forecast after June’s earlier than expected easing and with market expectations. The Bank stated that it would continue its policy of balance sheet normalization.

Governor Tiff Macklem explained at the press conference that the BoC saw policy in restrictive territory and with the economy now exhibiting excess supply, evidence of slack in the economy and labour market, inflation closer to the 2% target and expected to gradually ease further back to target it was appropriate for the BoC to re-weight its attention towards the downside risks. Macklem stated that if the economy evolved in line with the BoC’s expectations, it was “reasonable” to expect further easing in policy, but that the pace would be dictated by incoming data and the BoC would assess this on a meeting by meeting basis. Macklem did not reiterate that policy would be eased at a “gradual” pace.   

The BoC published its latest quarterly projections alongside today’s decision. GDP was lowered for this year to 1.2% from 1.5% - now in line with our forecast for 2024 – while the 2025 outlook was reduced slightly to 2.1% (from 2.2%) and remains above our own outlook of 1.7%. The BoC increased its 2026 forecast to 2.4% from 1.9%. It described the economy as moving further into excess supply as migration continued to deliver solid potential growth, relative to more lacklustre actual growth that had come in below BoC expectations so far in 2024. It expects growth to pick-up in H2 2024 in part supported by recovering real incomes supporting consumer spending and in part by increasing export growth.

The BoC left its CPI inflation forecast for 2024 unchanged at 2.6% (in line with our forecast), but raised its 2025 forecast to 2.4% from 2.2% (closer to our own view of 2.6%), while its 2026 view was lowered to 2.0% from 2.1%. The BoC noted that the latest inflation readings had softened. However, it showed this reflected decelerating goods price inflation, which had slowed to 0.3% y/y, while services inflation accelerated to 4.8%. It attributed much of the stickiness of services inflation to shelter – services ex-shelter inflation was a more subdued 2.9% in June. However, much of that was accounted for by communications prices, where the pace of disinflation had eased in recent months. The BoC remained wary that core services inflation remained persistent, reflecting still elevated wage growth, which it considered an upside risk to the future outlook. Macklem described the BoC as having to balance opposing forces of excess supply weighing on inflation and shelter and other services holding it up. He said he did not expect inflation to continue to ease in a straight line.

Our own view is now similar to the BoC’s revised outlook. We expect solid growth over the rest of 2024 to deliver annual growth of 1.2% before accelerating modestly. Moreover, we expect a further modest softening in headline inflation to deliver an annual rate of 2.6% this year. However, we are somewhat more cautious of the outlook for 2025, our 2.6% forecast still higher than the BoC’s upwardly revised outlook. As such, we expect the BoC to increasingly see less urgency in easing policy and we maintain our forecast for the BoC to ease policy again only in October, a move following further reassessment of the medium-term outlook. However, we were struck by the more cautious tone from today’s press conference – Macklem much more focused on downside growth risks in the light of growth coming in below the BoC’s expectations and employment rising as labour supply growth continue to be strong, as such we do see an increased risk of an additional cut in September, although on balance we suspect that concerns of too big a divergence with the Fed would put further downward pressure on the Canadian dollar. Further ahead, we are cautious of how far the BoC can ease policy and believe weaker productivity growth is likely to keep inflation more elevated than the BoC projects. As such, we forecast only four more cuts, taking rates to 4.25% by end-2024 and 3.50% by this time next year (and end-2025) - still in restrictive territory (the BoC estimates neutral rates at 2.25-3.25%) and above current market expectations.

Financial markets posted some reaction to todays meeting. The chances of a further 0.25% rate cut in September was raised to 60% from 40% before the meeting, October started to see some pricing (20%) from being fully priced for one cut and the cumulative view of two more cuts this year rose to 80% from just over 50% before the meeting. This was reflected in near term rates, 2-year bond yields fell by 5bps (to 3.60%) - around 18 month lows - but less in 10-year yields, which fell by 2bps (to 3.34%). The Canadian dollar fell by 0.1% against the dollar, but is now close to the lower end of the range seen over the last two years.