Ca reaction: Decisive BoC starts “gradual” easing modestly earlier

The Bank of Canada (BoC) cuts its policy rate by 25bps to 4.75% (Bank Rate at 5.0%) today and announced that it was continuing with balance sheet normalization. The move was not a surprise, around two-thirds of analysts expected this. We had expected the BoC to wait until the next meeting in July, but had recognised that April’s meeting had “cleared the way to announce an easing in monetary policy”, with a deceleration in core inflation and more recent trends in inflation having convinced the BoC to move earlier.

The BoC issued a relatively short accompanying statement. It highlighted that Q1 GDP had been somewhat softer than expected in April’s Monetary Policy Report (MPR) and that the economy was “operating in excess supply”. It also explicitly noted deceleration in April’s headline inflation to 2.7% and that indicators of the breadth of price increases had moved lower. The statement added that “Recent data has increased our confidence that inflation will continue to move towards the 2% target” – although it went on to note that “risks” remain and the Governing Council is “closely watching” the evolution of core inflation. This guidance was unchanged from April’s.

Governor Macklem went further in his press conference saying that the economy had made “considerable progress” and that policy “no longer needs to be as restrictive”. The Governor stated that if the economy evolved as was expected it was “reasonable to expect further rate cuts”. However, he went on to explain that with inflation expected to ease gradually, so should further easing in monetary policy.  He said the BoC would treat each meeting one meeting at a time. He also stated that the BoC was free to set monetary policy in accordance with domestic needs and did not need to move in lock-step with the US Federal Reserve (Fed). However, he also added that were “limits” to that divergence. He also added that the outlook for the economy was “looking like a soft landing”.  

Our own view has been since last October that the BoC would start a gradual easing cycle from mid-year – although on balance we had expected it wait until next month to begin its easing. Looking ahead, we continue to expect three cuts this year – indeed this is now consensus. However, as Macklem suggests, the timing of the next move will be data-dependent and could be bumpy. On balance, we now expect another cut at the next meeting, this having the advantage of timing gradual easing alongside longer-term forecasts from the BoC as well as we expect reflecting some softening in broader data. However, this will likely be a close call and the BoC will be wary that back-to-back cuts could send a different message to the gradual removal of restrictiveness as well as the risk of some firmer data over the coming six weeks. We then forecast a follow up cut in October. We continue to expect the BoC to ease the level of restrictiveness at a gradual pace in 2025 and currently pencil in a further three cuts to 3.50% by year-end, currently envisaging January, April and July.   

Financial markets reacted to this non-fully priced cut, particularly at the short-end of rate markets. July’s pricing for a second cut jumped from <30% to >60% and year-end expectations rose from a 60% chance of three cuts for the year to 95%. 2-year Government of Canada yields also dropped 5bp to 3.99%. However, the longer-term outlook was less affected with 10-year yields down 3bps to 3.38%. However, the more decisive move by the BoC – compared with a Fed that markets do not fully price easing in September – saw the Canadian dollar come under more pressure, the currency weaken by 0.5% initially, before recovering half of this loss to CAD 1.37 to the US dollar – moving back towards its May lows.