Bank of Canada would be ‘justified’ cutting rates by half a point. Here’s why
After proceeding at a tentative, 25-basis-point cut pace in the first three interest rate cuts of its cycle, many economists expect the Bank of Canada will take an oversized step lower in its upcoming decision on Wednesday.
The Bank of Canada is expected to take a larger step in lowering interest rates during its upcoming decision on Wednesday, following a series of cautious 25-basis-point cuts earlier in the cycle.
Currently, the policy rate stands at 4.25%, following the most recent quarter-point cut in early September. However, the Canadian economy has evolved significantly since then.
Inflation, which had been a primary concern, has dropped sharply, reaching 1.6%—below the central bank’s 2% target. Governor Tiff Macklem has emphasized that the Bank of Canada is as concerned about inflation falling too far below target as it is about inflation running too high. Although Macklem had warned that there might be “bumps” on the road to price stability, inflation has moderated faster than initially expected, with previous forecasts predicting a return to the 2% target by 2025.
Randall Bartlett, senior director of Canadian economics at Desjardins, suggests inflation may not decline much further, as the sharp drop in gas prices in September is unlikely to be repeated.
A 50-Basis-Point Cut in Sight?
Bartlett notes that economic output is also weaker than anticipated. While the Bank of Canada projected a 2.8% rebound in GDP for the third quarter, Desjardins’ analysis shows growth closer to 1.5%.
Canada’s labor market, despite some recent job gains in September, has shown signs of softening. Over the summer, unemployment briefly hit a seven-year high outside the pandemic. "The unemployment rate is still pretty elevated, and the trend isn't moving in the Bank’s favor,” Bartlett explains.
Additionally, the central bank’s surveys of consumer and business sentiment reveal little sign of increased spending. Taken together, Bartlett believes these factors point toward a 50-basis-point rate cut. If this happens, it would mark the first time in over 15 years that the Bank of Canada has reduced rates by such a margin outside of the pandemic.
Several financial institutions, including Scotiabank, RBC, CIBC, and BMO, also anticipate a half-point cut. However, TD Bank’s senior economist, James Orlando, suggests a quarter-point cut could still be justified, citing resilience in some labor market indicators.
As of Friday, currency swap markets reflected a 76% probability of a 50-basis-point reduction, with expectations of another 25-basis-point cut in December.
CIBC chief economist Avery Shenfeld even raised the possibility of a 75-basis-point “mega-move,” arguing that the Bank might front-load its rate cuts to get ahead of economic challenges. Shenfeld compared this scenario to the 100-basis-point hike the Bank implemented in July 2022 to combat soaring inflation.
U.S. Influence on Canada’s Rate Path
Despite domestic pressures, developments in the U.S. could influence the Bank of Canada’s decision. The U.S. Federal Reserve began its easing cycle in September with a half-point cut. Macklem has maintained that the Bank sets its policies based on Canadian conditions, but too wide a gap in interest rates between the two countries could weaken the Canadian dollar, increasing inflation on U.S. imports.
While the Bank of Canada may find justification for a 50-basis-point cut, the Fed's easing pace could prompt caution. Strong U.S. economic data has tempered expectations of rapid rate reductions south of the border, and a 75-basis-point cut in Canada could risk unsettling financial markets.
The U.S. presidential election will also play a crucial role in shaping the Bank’s future decisions, Bartlett warns. According to Desjardins, a second Donald Trump presidency could trigger an economic slowdown, as Trump has threatened to impose sweeping tariffs on U.S. imports, potentially pushing Canada into recession.
“The Bank of Canada will need to assess the impact of such tariffs on the Canadian economy, along with the broader effects of weaker U.S. economic activity,” Bartlett says. However, he notes that the Bank’s forecasts won’t reflect any new U.S. policies until they are formally announced, likely around the April monetary policy report.
Looking ahead to the Bank’s December decision, Bartlett expects another debate between a 25- and 50-basis-point cut, with sluggish economic activity potentially warranting a steeper reduction.
