The Bank of Canada is widely expected to deliver a third consecutive interest rate cut on Wednesday as inflationary forces continue to cool on both sides of the Canada-United States border.
Markets are also calling for the U.S. Federal Reserve to start its own easing cycle later this month, a move that economists tell Global News will help set its Canadian counterpart up for more rate cuts to come.
Derek Holt, vice-president and head of capital market economics at Scotiabank, tells Global News that he expects both the Bank of Canada and the U.S. Fed to deliver quarter-point rate cuts in September.
The Fed is set to announce its next rate decision on Sept. 18, two weeks after the Bank of Canada.
While the Canadian central bank is already 50 basis points into an easing cycle, its U.S. counterpart is playing catch-up.
Inflation has continued cooling for Canadians amid mild economic growth for much of 2024, allowing the Bank of Canada to start easing its benchmark policy rate from elevated levels in June. But concerns that inflation could reignite in the face of a still-hot economy south of the border were dampened by a particularly downbeat July jobs report in the U.S., cementing expectations that the Fed also needed to start cutting rates soon.
Fed chair Jerome Powell confirmed in late August that “the time has come” for a long-awaited policy shift.
How the Fed could impact the Bank of Canada
The remarks must have been reassuring for Bank of Canada governor Tiff Macklem, who was at Powell’s side at the Fed’s monetary policy conference at Jackson Hole, Wyo.
Holt says that despite the Canadian central bank embarking on a rate-cut cycle ahead of the Fed, Macklem likely had a limited runway ahead of him.
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“I think the catch for Canada is that eventually we need the Federal Reserve to start easing policy itself,” he says. “Otherwise, we would get to an earlier point at which the Bank of Canada’s easing probably would get stopped in its tracks.”
Macklem has maintained that he and his colleagues set monetary policy for Canada, not for the U.S., and that he is focused on the Canadian context when making interest rate moves.
But the exchange rate between the Canadian and U.S. dollars is heavily influenced by the policy rates on the respective sides of the border. A bigger divergence between the rates could hurt the loonie compared with the American greenback as investors seek better returns in the U.S. dollar.
If the exchange rate takes too much of a hit, that could make American imports more expensive for Canadian businesses — a phenomenon that risks refuelling inflation.
“I know the governor says that he’s not so fussed about the currency … but there’s a limit to that logic. If he were to continue to cut aggressively with the Fed on the sidelines, you’d get the Canadian dollar probably really softening,” Holt says.
In fact, the CAD-USD exchange rate appreciated through much of the past month. Holt suggests that’s owed to both growing expectations that the Fed will join the Bank of Canada in cutting rates and to the “somewhat resilient” Canadian economy and oil prices.
Claire Fan, economist with RBC, says there’s still a lot more uncertainty about the rate path in the U.S. after September than there is for the Bank of Canada.
Inflation has continued to cool towards the Bank of Canada’s two per cent target, last coming in at 2.5 per cent annually in July.
Fan says the “softening economic background” also tells the central bank that inflationary risks appear largely “contained,” giving the bandwidth needed to continue lowering interest rates without worrying too much that inflation will reignite.
She notes a shift among central bank communications away from putting heightened importance on every individual data point as confidence grows that conditions are in place to restore price stability.
Fan says the U.S. Fed will have to be more careful. There are plenty of outlying risks south of the border, not the least of which is the U.S. presidential election in November.
“The path forward for Bank of Canada is a more certain one, we are anticipating the Bank of Canada to go slow, steady with easing rate cuts into the end of 2025,” Fan says.
Where does the Bank of Canada's rate path lead?
Holt says that despite the runway for rate cuts, he’s not convinced the inflation risks are completely gone for the Bank of Canada.
With a federal election in Canada currently scheduled for no later than October 2025 and Prime Minister Justin Trudeau’s Liberals trailing in the polls, Holt sees a risk that the incumbent government hikes spending in a bid to capture votes, stoking inflation as a side effect.
He also points to renewed supply chain concerns tied to a looming port strike in the U.S., as well as the recent rail stoppage in Canada, as possible risks to the inflation outlook.
Despite a near-consensus among economists and market watchers that the path for interest rates in Canada is lower, both Holt and Fan warn not to expect oversized moves from the Bank of Canada, which is widely forecast to keep cutting rates by a quarter of a percentage point.
Anything larger than that would send the wrong message to markets, Holt argues, that the Bank of Canada is looking to speed up the pace of easing. Market bets for more aggressive cuts would run counter to the central bank’s efforts to keep borrowing costs under control in the easing cycle, he says.
Holt says the message from the Bank of Canada has been that the rate-cut cycle won’t be as rapid as it was on the way up, when the central bank routinely delivered hikes of 50, 75, even 100 basis points at times to tamp down decades-high levels of inflation.
The economy isn’t in an “emergency” scenario that warrants those kinds of sudden shifts, he argues.
Fan agrees. While there have been signs of slowing in the economy and weakness in the labour market, Canada does not appear to be on the verge of a severe slowdown that would require a quick pivot to stimulating monetary policy.
RBC expects the unemployment rate will rise a few more ticks to 6.7 per cent before levelling off and recovering somewhat starting in 2025 as interest rates ease and household and business spending picks back up.
“The bottom really hasn’t fallen out of the economy to the extent that will require very steep rate cuts from the central bank just yet,” Fan says. “Slow and steady is really how we are expecting the Bank of Canada to be approaching this upcoming easing cycle.”
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