Ca reaction: BoC cuts again, Fed outlook provides free reign

The Bank of Canada (BoC) cut its main policy rate again by 0.25% - the third successive cut to 4.25% (Bank Rate cut to 4.50%) and the Bank stated that it continued to normalize its balance sheet. This was in line with most market forecasts. After July’s cut we had argued that risks of a cut in September had increased, but that we considered the BoC moving too far ahead of the Fed would create weakness in the Canadian dollar that would likely restrain further action this time. In the event, the post-US payrolls recession concerns that have seen markets price 200bps of US Fed Funds cuts over the next 12-months, meant that the Canadian dollar gained 2.6% to its firmest since March creating no such constraint on the BoC.  

The BoC acknowledged the firmer domestic economic growth in Q2, but highlighted the recent softness suggested by monthly data for June and July. It also continued to note ongoing deceleration in the labour market, despite wage growth remaining elevated compared to productivity. The BoC also acknowledged that inflation slowed further to 2.5%, in line with its expectations. It ststaed that shelter price inflation remained high, but was starting to slow and pointed to ongoing inflation pressure in “some” other services, somewhat more relaxed than July’s statement that inflation was elevated in services “that are closely affected by wages”. Moreover, the statement noted that oil prices were lower than assumed in July.

Governor Tiff Macklem’s press conference once again leaned into a dovish message. He said that while the BoC was not committed to a specific path and would take its meetings one at a time, he said it was “reasonable to expect further cuts in policy rate”, adding that the Bank needed “to guard against the risk that the economy is too weak and inflation falls too quickly”. Macklem explained that with excess supply in the economy, inflation should be expected to continue to fall. Despite the BoC forecasting growth of 2.1% next year and 2.4% in 2026, neither we nor consensus are so bullish. Macklem went on to say that while there was a strong consensus for a 25bp cut today, the Committee discussed scenarios where it might have to cut rates more quickly (as well as scenarios where this would not be the case).  

To our mind a number of factors have shifted in the near-term. Oil prices have weakened and may well remain more subdued to year end, mechanically lowering the Canadian CPI inflation outlook. We have lowered our outlook for Canadian CPI for next year. Current Fed pricing is providing no restraint via the currency to the BoC to continue to loosen. As such, we continue to see a further rate cut in October, despite today’s move and forecast – on balance – an additional cut in December, taking the policy rate to 3.75%. However, while we acknowledge significant uncertainty, we continue to see the election outcome as important both to the US and Canada. A Trump win would likely restrict the space that the Fed has to ease policy relative to current expectations and would likely independently boost the dollar, while tariffs on the rest of the world would also likely provide a relative boost to Canadian output next year. All are likely to restrain the BoC in its pace of further easing – a process that could be underway by this year-end. We envisage the BoC slowing the pace of cuts in 2025, and, now expecting a front-loaded five cuts this year, forecast just two cuts next to 3.25%, around 50bps above market rate expectations.

Yet markets were already priced for a dovish BoC and markets posted a mixed reaction to today’s meeting. Expectations of a 50bps rate at one of the remaining two meetings this year were pared back to 30% from 40%. 2-year Government of Canada bond yields dropped 3bps to 3.17% and 10-year yields dropped 2bps to 3.02%, but the Canadian dollar gained a further 0.2% versus the US dollar, having sold off a little in recent days.