Bank of Canada holds rates again. So when will cuts begin?

Click to play video: 'Bank of Canada holds key interest rate steady at 5%'
Bank of Canada holds key interest rate steady at 5%
WATCH: The Bank of Canada left its benchmark interest rate unchanged at 5.0 per cent for the third consecutive decision on Wednesday, the final announcement in 2023. Mackenzie Gray reports. – Dec 6, 2023

The Bank of Canada left its benchmark interest rate unchanged on Wednesday and continued to warn future hikes aren’t off the table, even as market watchers shift their eyes toward rate cuts in 2024.

The central bank kept its policy rate at 5.0 per cent in its third consecutive decision and its final rate announcement of 2023.

In a statement announcing the widely expected hold, the Bank of Canada pointed to a weakening economy and easing in price pressures like consumer spending as signs that tighter monetary policy is working to bring down inflation.

Overall inflation cooled sharply to 3.1 per cent in October, down from a peak of 8.1. per cent in June 2022. Canada’s economy meanwhile contracted in the third quarter with a steeper drop than most forecasts expected.

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But the Bank of Canada’s governing council warned that it “remains prepared to raise the policy rate further” if it doesn’t see more signs of progress in its preferred core inflation metrics and other factors like wage growth, inflation expectations and consumer price setting behaviour.

Click to play video: 'With Canada’s interest rates temporarily on hold, what is the central bank’s next move?'
With Canada’s interest rates temporarily on hold, what is the central bank’s next move?

Inflation set to go 'lower' but path could be bumpy: BMO

The central bank has raised its policy rate 4.75 percentage points since March 2022 in an effort to slow economic growth, discourage spending and rein in demand, while also making loans like mortgages more expensive for Canadians.

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Back of Canada governor Tiff Macklem said in a speech last month that the “excess demand” that was fuelling inflation has been stripped out of the economy — language that was mirrored in Wednesday’s statement.

Benjamin Reitzes, managing director of Canadian rates and macro strategist at BMO Capital Markets, tells Global News that inflation is indeed likely to head “lower” in the months ahead with expectations the economy will continue to slow.

“But that doesn’t mean it’s going to move in a straight line,” he warns, citing some possible bumps in the road back to the Bank of Canada’s two per cent inflation target, a goal it currently has set for mid-2025.

Click to play video: 'Rising costs taking toll on mental health, causing ‘inflation isolation’: poll'
Rising costs taking toll on mental health, causing ‘inflation isolation’: poll

The economy could rebound stronger than expected, Reitzes says, or a global shock in oil prices could bring the central bank back off the sidelines to keep inflation expectations in check.

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The Bank of Canada on Wednesday also noted rising pressures on the shelter component of the consumer price index, even as overall inflation cooled.

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Canada’s once-tight labour market has also shown signs of easing as of late as job gains fail to keep pace with rapid population growth, driving up the unemployment rate. However, the Bank of Canada continued to flag annual wage growth in the range of four to five per cent as something it’s keeping tabs on.

Reitzes says higher wages are the “big risk” for Canada’s inflation outlook right now, particularly given a Statistics Canada report also released Wednesday that showed productivity declined nationally for the sixth consecutive quarter.

Declines in productivity and rising wages mean it costs more for Canadian businesses to produce goods and services, which is “inflationary,” he explains.

Macklem has warned in the past that elevated wages are not consistent with getting inflation back to two per cent unless they come with gains in productivity.

When will rate cuts begin?

Avery Shenfeld, chief economist at CIBC Capital Markets, said in a note to clients on Wednesday morning that the Bank of Canada “toasted small victories” on the inflation front with its latest decision, but was not yet ready to drop its warning that rates could rise again.

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“But current trends are clearly leaning away from that, and the bank’s nod to broader progress against inflation and the fact that the economy is no longer clearly overheated suggest that the central bank isn’t at this point really giving much thought to additional tightening,” he said.

Reitzes, too, says that while further shocks to inflation are possible and could put rate hikes back on the table, he’s not taking the Bank of Canada’s threats of higher rates “that seriously.”

“At this point, it does look like the next move will probably be lower for Canada, not higher,” he says.

Click to play video: 'Mortgage rate relief could be on the horizon for Canadians: economists'
Mortgage rate relief could be on the horizon for Canadians: economists

In Reitzes’ view, the bank’s warnings are more about reassuring Canadians that it will do everything in its power to return inflation all the way back to the two per cent target after a prolonged period of price pressures.

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He doesn’t expect the Bank of Canada’s focus to shift to rate cuts until monetary policymakers see a series of inflation prints in the mid-two per cent range, giving the central bank confidence that it can pump the brakes on the tightening cycle.

“That isn’t likely until the second quarter at some point,” Reitzes says. “It could even get delayed until the third quarter if we don’t get those favourable inflation numbers.”

Royal Bank of Canada economist Claire Fan also said in a note to clients on Wednesday that she’s expecting cuts to begin in the second half of 2024, though a steeper economic downturn could bring that timetable forward.

Other big Canadian banks are more ambitious with their rate cut forecasts.

TD Bank said Wednesday that the first interest rate cut from the Bank of Canada could come as early as April.

CIBC is a bit later, with Shenfeld saying Wednesday that the bank is eyeing cuts starting in June. But CIBC’s forecast sees a substantial drop in the policy rate of 1.5 percentage points before the end of 2024.

Money markets are already signalling a possible rate cut by March with a full 25-basis-point drop priced in for April, according to Reuters.

As BMO’s chief economist Doug Porter put it in a note Wednesday, “the countdown clock to rate cuts has begun, even if the Bank isn’t saying so.”

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How the housing market could react in the new year

Scotiabank’s chief economist Derek Holt said in a note Wednesday that the Bank of Canada couldn’t remove its guidance about the possibility of higher rates without spurring a flood of rate cut bets in financial markets.

The bond market is already pricing in rate cuts for the coming year — yields on the key five-year government of Canada bond have reversed course from a run-up in the early fall and now sit at their lowest point since May, Holt noted.

Bond yields influence fixed-rate mortgages on offer at Canadian lenders, with declining yields signalling better rates to come for homebuyers and those with mortgages up for renewal.

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Holt said the five-year GoC bond yields are dropping as Canadians lock in mortgage pre-approvals to gear up for house shopping in the new year. On top of that, Canadians have largely been gaining jobs and bringing in higher wages this year, putting many in prime position for a run at a possibly busy spring housing market.

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Reitzes notes on the other hand that many housing markets in Canada continue to favour buyers, with competition limited amid higher rates and a growing supply keeping sales “soft.”

He expects those trends will continue through the winter and into the spring, with housing activity and prices “bottoming out” in the second half of next year before the “comeback” begins.

If the Bank of Canada’s rates start to fall, that could stimulate a boost in the market, but Reitzes notes that would likely happen only when the economy has weakened further — putting many buyers back on the sidelines should their incomes take a hit.

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