Tomorrow's decision will tell us if The Bank is afraid of a recession
The Bank of Canada's upcoming policy decision on October 23 has drawn considerable attention as analysts weigh the magnitude of the rate cut. There is broad agreement that the policy rate will drop; the controversy relates to how aggressive analysts think the Bank of Canada needs to be with its cuts.
With inflation at 1.6% on the mend and economic growth showing signs of strain, experts are divided over whether The Bank will make a modest 25-basis-point cut or a more aggressive 50-basis-point reduction.
It is rare for the Bank of Canada to make a 50-basis-point (half of a percent) cut, and doing something like this now could be perceived by the market as aggressive and purposeful or a sign of panic having been caught on its back foot.
The Economic Context
The Canadian economy has recently exhibited a dual narrative. On the one hand, inflation appears to be under control. September’s Consumer Price Index (CPI) data shows that inflation had fallen to 1.6%—under the Central Bank’s average long-term target. However, there are still pockets of inflationary pressure, particularly in sectors such as housing and services. Meanwhile, broader economic growth has been weak, with real GDP growth falling short of the Bank’s projections and some analysts flagging an increasing risk of economic stagnation or recession.
Growth in full-time employment has been lacking for the entire 2024 calendar year, and unemployment is now 6.5%, roughly 1 percent higher than pre-pandemic. That’s a considerable achievement, considering Canada’s population growth in recent years. However, rising unemployment will undoubtedly raise questions about further immigration in the coming year.
As the Bank of Canada assesses its next move, it finds itself in a delicate balancing act. It must weigh the benefits of continuing its monetary policy easing cycle—designed to stimulate economic growth—against the risks of doing too much too soon, potentially re-igniting inflationary pressures or destabilizing financial markets.
This is borne out by reports that some real estate agents expect buyers to “jump in with both feet” once they see enough rate cuts.
Perhaps buyers are slower to trust forward guidance because the Bank of Canada once promised low rates for longer in the past and then changed course. Bank of Canada Governor Tiff Macklem was quoted in July 2020 saying, “Interest rates are very low, and they are going to be there for a long time.”
Bank of Canada plans to keep interest rate near zero until 2023 — CBC News — October 2020
The Case for a 25-Basis-Point Cut
Stay the course and maintain momentum with no surprises
Several leading institutions, including the Bank of Montreal and TD Bank, lean toward a 25-basis-point cut. They believe the central bank will take a more cautious approach consistent with past rate cut cycles.
According to BMO’s latest report by Michael Gregory, the central bank is in a position where inflation is much more manageable, and attention has turned toward a cooling economy. Mr Gregory’s team expects the bank to deliver repeated quarter-percentage-point reductions until the policy rate reaches a neutral 2.5%. BMO feels this adequately reflects a greater urgency to reduce interest rates.
The TD Economics report by Beata Caranci also anticipates a cautious 25-basis point rate cut by the Bank of Canada. The report notes that inflation has moderated, mainly due to falling energy prices, but warns against accelerating cuts. Key concerns include wage growth, high household debt, and the potential for re-igniting housing demand. If housing remand grows too quickly, it could re-ignite inflation. The bank must balance encouraging business investment with avoiding financial risks. The report suggests clear communication is essential if more significant cuts are pursued.
Both BMO and TD emphasize the importance of managing the bank’s credibility and longer-term inflation expectations. With inflation having only recently reached the 2% target, there is little room for error, and a drastic cut might signal to the market that the bank is more concerned about short-term economic performance than its broader, long-term objectives. By opting for a more conservative 25-basis-point reduction, the Bank of Canada can maintain its focus on controlling inflation without overstimulating the economy.
The Case for a 50-Basis-Point Cut
Aggressive Action to Boost the Economy
In contrast, RBC and Desjardins expect a much more aggressive approach.
Desjardins calls for a 50-basis-point rate cut in its latest economic outlook, mirroring the US Fed’s 50-point September cut. Desjardins argues that the central bank has waited too long to normalize rates, given the extent of the economic slowdown. Desjardins notes that the 1.6% inflation figure in September, while technically at the bank’s target, represents a pivotal moment in the inflationary narrative. Nearly half of all inflation components are growing at rates below 1%, and the central bank is at risk of keeping monetary conditions too tight, thereby suppressing growth at a time when the economy can least afford it.
As Desjardins sees it, Canada’s economy is showing signs of strain, with growth stalling in June and expected to remain weak. Real GDP growth for Q3 2024 is tracking at 1.0%, far below the Bank of Canada’s 2.8% forecast. Unemployment is rising, particularly among young people and newcomers, while inflation remains high—19% above pre-pandemic levels. Although interest rates are falling, many Canadians will face higher mortgage payments at renewal, creating additional financial pressure. Higher prices and borrowing costs are expected to strain household finances further. Thus, a half-percent drop in the central bank policy rate tomorrow would provide relief to the economy more quickly than two quarter-percent drops between tomorrow and December. Rates should be normalized more rapidly. By cutting rates more aggressively now, the Bank of Canada would bring rates closer to the “neutral” range, potentially around 2.25% by 2025. This would not only support growth in the near term but also provide more breathing room for the economy to weather any future shocks
RBC Royal Bank also believes the Bank of Canada is expected to cut its overnight rate by half a percent, reducing it to 3.75%, because the Canadian economy has been underperforming and unemployment has been rising. After three consecutive quarter-percent cuts, the BoC must act more aggressively to stabilize the economy. RBC believes inflation is now a secondary concern—jobs and the economy have taken centre stage.
The Road Ahead
The decision on October 23 will hinge on how the Bank of Canada prioritizes its dual mandate of controlling inflation and supporting economic growth. In line with BMO and TD’s expectations, a quarter-percent cut appears to be the safer, more conservative choice. It offers a middle ground between addressing slowing growth and maintaining inflationary control.
However, if the bank is more concerned about the broader economic slowdown, RBC and Desjardins’ call for a 50-basis-point cut could become the more likely scenario. The aggressive stance would signal that the bank is serious about stimulating the economy, even at the risk of inflation briefly overshooting its target.
The bank’s decision will likely influence the trajectory of the Canadian economy for the coming years as it navigates a complex environment of slowing growth, weakening demand, and persistent inflationary pressure. However, interest rates are a blunt instrument for economic growth — equivalent to “spray and pray.” While lowering the policy rate to the neutral range will loosen up the economy, the various levels of government really should focus on the long-term economic drivers:
Taxes: Tax cuts and rebates to sectors and skill sets that need help.
Deregulation: Less red tape and faster turnaround for government approvals (or rejections) of business activity.
Infrastructure: Invest in infrastructure. For example, if you want people telecommuting from rural areas, push fibre networks northward. If you want people to come into the office and spend money at local businesses, give them faster and cheaper commutes on public transit.
Encouraging consumer and business spending would typically be on the list above. However, Canadian consumers already have near-record debt levels. Encouraging more debt would be unhelpful at a time when they should be deleveraging.
Likewise, Canadian corporations have higher debt levels than their G7 contemporaries. Interest expenses were high in 2021 and are likely higher today because the Bank of Canada began raising rates in 2022. Corporations are unlikely to be the white knight rescuing Canada from an economic slowdown.
Corporations’ Ratio of Interest to Disposable Income
