Bank of Canada may need to make bigger cuts, say economists

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The Bank of Canada cut interest rates for a third consecutive time by 25 basis points on Wednesday, leaving its benchmark lending rate at 4.25 per cent.

Here’s what economists are saying about the move, and how much more they expect the bank to cut.

‘Cautious approach’: CIBC

The Bank of Canada took a “cautious approach” and played it safe in cutting rates by just 25 basis points, Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in a note, adding that the latest reduction leaves “rates still well above where they will have to head to get the economy really moving again now that inflation is less of a threat.”

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Market-based measures and some economists had upped the odds of a 50-basis-point cut following the release of gross domestic product data on Friday that showed the Canadian economy could post weaker growth in the third quarter than forecast by the Bank of Canada.

It’s possible, Shenfeld said, that bank officials could open the door to rate cuts of a larger magnitude if growth and inflation come in weaker than expected.

“For now, we’re calling for two more 25 basis point moves this year, en route to a roughly 2.5 per cent overnight rate next year, but a disappointment in upcoming jobs data could still compel a bolder pace of easing.”

Statistics Canada released jobs number for August this Friday.

‘Less dovish’: Capital Economics

Risks to the economy mean that future rate cuts “lie in the direction of a more aggressive pace,” Stephen Brown, deputy chief North America economist at Capital Economics, said in a note.

Markets, Brown noted, had priced in a 25 per cent chance of a 50 basis point cut at today’s announcement, which he said was “understandable” based on a weaker outlook for GDP and the labour market.

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“The tone of the communications was less dovish than we expected following the signs of a slowdown in GDP growth at the start of the third quarter, suggesting a relatively high bar to a larger 50 basis point cut at the next meeting in October,” Brown said.

Brown noted that Bank of Canada governor Tiff Macklem acknowledged in opening comments during a press conference that the bank needs “to increasingly guard against the risk that the economy is too weak and inflation falls too much,” but the governor also noted that wages growth is still high compared with productivity and shelter’s contribution to inflation remains a concern.

Brown thinks the bank is looking to make further headway on slowing core inflation before it contemplates a larger cut.

“For now, our assumption is that the bank will continue to cut by 25 basis points at each meeting until the policy rate reaches 2.5 per cent next year, but the risks lie in the direction of a more aggressive pace,” he said.

‘A long way to go’: Rosenberg Research

The Bank of Canada warned of “elevated wage growth” and shelter and other services “holding up inflation,” making the tone in its latest policy statement announcement “less dovish” than the July 24 rate decision, David Rosenberg, founder and president of Rosenberg Research & Associates, said in a note.

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But don’t be fooled. Rosenberg thinks that was at least partly in service of discouraging markets from “getting too carried away with the extent of future interest rate relief.”

The bank can’t camouflage the more rate cuts are coming, Rosenberg said, noting that the official statement on the latest cut spoke of “soft” economic activity in June and July and a slowing labour market.

“The Canadian economy is on a very shaky foundation, as absent the population boom, the economy would be contracting at a -2.4 per cent annual rate,” he said.

With inflation behaving and excess supply in the economy expected to continue pushing it down, the question is what is the “terminal” rate for this stretch of reductions. Markets have priced in an end point of 2.75 per cent. Looking at what is “normal” over over the past five-, 10- and 20-year period, rates have hit 2.3 per cent, 1.6 per cent and 1.8 per cent, respectively. “So, Mr. Macklem and crew, you still have a long way to go before the bottom in rates is in,” Rosenberg said.

‘Unlock savings’: Desjardins

Macklem is now equally worried about inflation falling below the bank’s two per cent target as being above it, said Royce Mendes, an economist at Desjardins Group, in a note.

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“With the economy already operating with slack, a rebound is therefore necessary to keep inflation (from) falling below the two per cent target,” Mendes said.

However, the economist doesn’t think that the three rate cuts the bank now has under its belt “will do the trick” in terms of boosting growth, which showed signs of slowing in June and July.

“The housing market is barely responding to lower rates as affordability remains a major hurdle,” he said. “To unlock the savings that households have built up, we think the Bank of Canada will need to continue cutting interest rates at each of its decision dates until at least the middle of next year.”

Data on Friday showed that the savings rate in Canada rose to 7.2 per cent, its highest level since 1996, excluding the pandemic.

With growth looking ragged, Mendes thinks the chances have risen of a 50 basis point cut at the bank’s next announcement on Oct. 23.

‘Undershooting’ the bigger concern: Alberta Central

Charles St-Arnaud, chief economist at credit union Alberta Central, believes Wednesday’s announcement shows the Bank of Canada has shifted its focus to supporting economic growth in order to avoid “undershooting” its inflation target.

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That target is two per cent. The last consumer price index reading was 2.5 per cent for July.

“While an upside surprise to inflation could lead to a pause (in rate cuts), we think the risk could be of an acceleration in the path of the cut, especially if the labour market were to falter,” St-Arnaud said.

So far, significant layoffs have been avoided and that will make the difference between a soft and a hard landing for the economy, he said. The economist is calling for a further series of 25 basis points cuts at the Bank of Canada’s October, December, January, March and April policy announcements bringing the lending rate to three per cent — the top of the bank’s neutral rate range.

The neutral rate is one that neither stimulates nor depresses economic activity. Borrowers take note: St-Arnaud is calling for rates to end this cycle at a higher level than in the pre-pandemic period and that they are “likely to be higher … for a long period.”

• Email: gmvsuhanic@postmedia.com

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