The Bank of Canada is expected to cut its overnight rate by another 25bps on Wednesday with the statement arriving at 9:45 a.m. ET and followed by a press conference 45 minutes later, noted Scotiabank.
There won't be a Monetary Policy Report (MPR) or forecast update with this one while the next forecasts will be offered at the Oct. 23 decision. No changes to quantitative tightening (QT) are expected, said the bank and the BoC likely remain of the view that settlement balances are still too high and that the persistent CORRA spread over the policy rate is driven by factors other than QT.
A quarter-point rate cut is widely expected and more than fully priced. So is another quarter-point cut at the October meeting and then markets are pricing a further such move at the December meeting, stated Scotiabank. If delivered, this would take cumulative easing to -125bps from a 5% policy rate peak to 3.75% by year-end.
Risks to this straight-line trajectory include the course of data and market developments, possibly the contents of the federal government's fall fiscal update sometime in November or December that may include election year "goodies," plus US election aftermath, added the bank. To paraphrase former Governor Stephen Poloz when he skipped between two cuts in early 2015, policy adjustments don't have to go in a straight line and there is merit to keeping some powder dry.
The Canadian rates curve is generously priced for rate cuts and/or doesn't presently believe in applying term premia. OIS markets have the policy rate falling to 3% by next summer. The five-year Canada bond yield is priced at about 3% which is 15bps above the undershooting low in early August and in the ballpark of the lower end of the BoC's estimated neutral rate range plus very little term premiums. A recession with or without financial market dysfunction would drive a lower yield, but neither is in Scotiabank's forecasts.
In short, the Canadian rates curve is "significantly" priced for perfection in the delivery of aggressive rate cuts. What could add to this pricing would be bigger and sooner cuts compared with the 25bps per meeting pace that is roughly priced.
And yet, the case against up-sizing cuts such as delivering a half point or bigger move along the way includes the following points:
— Up-sizing cuts could send a negative signaling effect by way of saying to Canadians and markets that the BoC sees something it's really worried about to merit picking up the pace.
— Up-sizing is an option the BoC should preserve for potentially more exigent circumstances.
— With markets already aggressively priced for easing, up-sizing even just once would have markets price another up-sized move and perhaps more. The BoC may not be comfortable with being pushed into this position by markets while presenting the risk of having to disappoint markets at some point. This should matter to the Governing Council, though it tends to be aloof toward markets.
— The BoC's forward guidance has said the path down wouldn't be the same as the path upward. This means that the big hikes wouldn't be followed by out-sized cuts and so the paths up and down wouldn't be symmetrical to one another. The BoC's forward guidance has performed poorly over the years and violating current guidance would do nothing to improve guidance.
— Up-sizing cuts could be treated as a case to raise inflation forecasts over 2025-26 and potentially introduce erratic monetary policy.
— The last point involves repeating Scotiabank's take on recent gross domestic product (GDP) growth and the uncertainties going forward as argued here. The private economy is recently quite weak as Q2 GDP growth was largely only driven by the government giving its workers retroactive wage increases. The BoC may wish to hold off against up-sizing until it can observe what happens as this effect on growth drops out and in the context of uncertainty toward whether hoarded savings get redeployed by consumers.
In the bank's opinion, the BoC isn't out of the woods when it comes to inflation risk and should proceed very carefully without overreacting to a handful of months of data. Immigration remains wildly excessive. Housing shortfalls that existed before the pandemic have grown more acute and are likely to remain that way throughout the decade and possibly beyond. Real wage growth is accelerating while productivity continues to tank.
Fiscal policy is still adding to GDP growth and it's reasonable to think there will be more stimulus applied into an election year given the federal government's poor polling, according to Scotiabank. The potential combination of monetary and fiscal easing feeding off one another may well reignite inflation risk.
It's also very premature to conclude that serial supply chain shocks are over in light of geopolitical tensions, soaring shipping costs due to Red Sea tensions, and labor strife in Canada and the US.
It's also not clear that the US Federal Reserve will consistently have the BoC's back into 2025. The US economy remains remarkably resilient in yet another quarter marked by consensus chasing strong growth higher after Q2 was revised up to 3% q/q seasonally annual adjust rate (SAAR). Scotiabank has argued that seasonal adjustment factors are complicating the interpretation of recent inflation and jobs data. US election presents deeply uncertain effects on the outlook.
Scotiabank Previews Wednesday's Policy Meeting
Comments