Here's why markets are betting on a Bank of Canada rate cut on ...

Investors and analysts have grown increasingly confident that the Bank of Canada will deliver a second consecutive rate cut on Wednesday to support the economy as inflation worries ease and signs of economic weakness grow.

As of Monday night, bond markets were pricing in 90% odds of a quarter-point rate cut, which would bring the Bank’s overnight target rate to 4.50%. This would be welcome news for those with variable rate mortgages and lines of credit, as they would see their interest costs reduced for the second time in as many months.

“Inflation is much better behaved today and the progress that’s already been made should render this a relatively easy decision,” National Bank Financial economists Taylor Schleich and Warren Lovely wrote in a recent note. “Empirical analysis of past interest rate cycles also lend support to the BoC starting off with back-to-back cuts.”

Here’s a rundown of some of the factors that should give the Bank of Canada confidence in moving ahead with its highly anticipated rate cut this week:

1. Easing inflation

Recent data from Statistics Canada shows that inflation has continued to moderate, with the headline Consumer Price Index (CPI) inflation in June easing to an annualized pace of 2.5%, down from 3.4% in May. This marks the lowest inflation rate in over two years, driven by declines in energy prices and slower growth in food prices.

In the view of CIBC’s Katherine Judge, the June CPI data “gave the Bank of Canada what it needed in order to cut interest rates.”

2. Softening labour market

The latest employment data also revealed a labour market that’s increasingly struggling. Canada’s unemployment rate continued to trend higher in June, rising to 6.4%. That translated to an additional 42,000 unemployed individuals in June, increasing the national total to 1.4 million.

Bruno Valko, VP of national sales for RMG, called the June employment numbers “awful.”

“We see this in our industry with clients and their battles to buy homes, renew at higher rates, and so on,” he wrote in a note to subscribers. “Hopefully, now, the economists see our true job market. It is not resilient. It is weak [and] the Bank of Canada will notice.”

However, regardless of the near-term monetary policy path, National Bank Financial expects the national unemployment rate to continue to rise to about 7% by later in the year.

3. High interest rates are taking a toll

The longer interest rates remain elevated, the higher the toll they’re expected to take. And the Bank of Canada is acutely aware of this. Recent economic indicators paint a picture of growing economic pain, creating a sense of urgency for further rate relief.

The Bank of Canada’s latest Business Outlook Survey indicates that sales outlooks remain pessimistic, especially for businesses linked to discretionary spending. Investment spending plans are also below average due to weak demand, high interest rates and cost concerns.

Similarly, consumer sentiment remains subdued, according to the BoC’s latest Survey of Consumer Expectations. Financial stress remains high among consumers, with many planning to cut spending and focus on paying down debt. Job security perceptions have worsened, particularly in the private sector, and consumers are generally pessimistic about future economic conditions, impacting their overall spending intentions.

Last week’s retail sales report for May confirmed Canadians continued to reduce discretionary spending with sales falling by 0.8% month-over-month.

“Another data release, another economic indicator justifying our call for the Bank of Canada to cut the policy rate by 25 basis points,” Desjardins economist Maëlle Boulais-Préseault wrote in response to the figures. “And if the headline for retail looks bad, on a per capita basis it looks even worse due to still-surging population growth.”

4. Reduced risk of U.S.-Canada policy divergence

Earlier this year, concerns arose about policy divergence between the Bank of Canada and the U.S. Federal Reserve due to falling inflation in Canada and persistent inflation in the U.S. This divergence suggested the BoC might cut rates while the Fed raised them, risking a weaker Canadian dollar and higher import costs​.

However, in June, lower-than-expected U.S. inflation increased the likelihood of multiple Fed rate cuts this year, a significant shift from previous expectations of prolonged high rates. As a result, concerns about policy divergence have subsided, giving the BoC more flexibility in its rate decisions without the associated risks of diverging too much from the Fed’s policies.

“We (still) don’t see BoC-Fed divergence concerns impacting that decision, especially now that the market has coalesced around a fall FOMC cut,” the National Bank economists noted. “The limits of policy rate divergence shouldn’t be put to the test this cycle.”

Lingering concerns for the Bank of Canada

While there are strong arguments for a second straight rate cut, the Bank of Canada may still have some reservations about cutting rates too aggressively.

Wage growth still high

Despite signs of a softening labour market, wage growth remains relatively high, with most traditional wage measures stuck around the 4% annualized mark, though down from a peak of around 4.5% and 6%. Elevated wage growth can contribute to inflationary pressures.

This persistent wage growth, driven by tight labour market conditions and high demand for workers, has been a challenge in the fight against inflation. However, many economists and the Bank of Canada itself have said they expect wage pressures to continue to ease.

“The fact that wages are moderating more slowly than inflation is not surprising: wages tend to lag adjustments in employment,” BoC Governor Tiff Macklem said in a speech last month. “Going forward, we will be looking for wage growth to moderate further.”

Core inflation remains somewhat sticky

Despite a favourable inflation report for June, the readings just one month earlier came in surprisingly hot. And while headline inflation did drop more than expected in June, core inflation still remained above 2% on a seasonally adjusted annual rate (SAAR) basis.

“Nonetheless, we don’t think theGoverning Council will miss the forest for the trees,” the National Bank economists wrote. “Inflation is irrefutably better behaved than it was in the past.”

The latest big bank rate forecasts

The following are the latest interest rate and bond yield forecasts from the Big 6 banks, with any changes from our previous table in parentheses.

Current Target Rate:Target Rate:Year-end ’24Target Rate:Year-end ’255-Year Bond Yield:Year-end ’245-Year Bond Yield:Year-end ‘25BMO4.75%4.25% (+25bps)4.00% (+100 bps)3.30% (+5bps)3.15% (+20bps)CIBC4.75%4.00% 2.75%NANANBC4.75%4.00% (-25bps)3.00% 3.15% (-20bps) 3.00% RBC4.75%4.00%3.00%3.00%3.00% Scotia4.75%4.00% (-25bps)3.25% (+25bps)3.45% (-5bps)3.50%TD4.75%4.25% 2.75% 3.25% (-25bps)2.65% (-25bps)

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Last modified: July 22, 2024