Introduction to Bank of Canada’s Rate Cut
The Bank of Canada is expected to cut interest rates by 25 basis points on September 17, marking the restart of its easing cycle after a summer pause. This decision is largely based on the current state of the Canadian economy, which has shown significant signs of weakness.
Economic Weakness in Canada
Canada’s economy has been experiencing slack conditions, with a real-time output gap of around -1.5%, just above recession levels. The country shed 65,500 jobs in August, pushing the unemployment rate to its highest level in nine years outside of the pandemic. Additionally, GDP contracted by 1.6% in the second quarter due to U.S. tariffs on Canadian exports. These factors contribute to a stronger case for rate cuts in Canada compared to the U.S.
Comparison with the U.S. Economy
The U.S. economy, although showing signs of slowing down, has a different economic backdrop. The Federal Reserve is also expected to cut rates, but mainly to bring policy closer to neutral rather than addressing urgent economic weakness. The U.S. unemployment rate remains low at 4.3%, and wage growth has re-accelerated. In contrast, Canada’s economy has more unused capacity, giving the Bank of Canada room to focus on forward-looking monetary policy.
Expected Outcomes and Market Reactions
The Bank of Canada is expected to leave the door open for more rate cuts, especially if the next inflation reading shows little sign of heat. The consensus forecast expects headline inflation to rise to 2.0% in August, but core measures are expected to remain steady. Markets have already responded to the expected rate cuts, with U.S. mortgage rates dropping to 6.35%, their lowest in nearly a year. In Canada, bond yields have edged lower, putting downward pressure on fixed mortgage rates.
Fed Cut Expected, Mortgage Rates Reacting
The Federal Reserve’s expected rate cut is largely seen as a move to bring policy closer to neutral. U.S. payroll growth has slowed, but the unemployment rate remains close to the Fed’s long-run estimate. Markets are already responding, with Treasury yields briefly slipping below 4% and mortgage rates dropping.
Market Expectations Rising
A recent poll found that nearly 80% of economists expect the Bank of Canada to cut its rate by 25 basis points, with most looking for at least one more cut before year-end. Markets have already priced in the expected move, and the focus has shifted to how far the easing cycle will ultimately go. For borrowers, the shift is already translating into modest improvements in interest costs.
Why Some Say the BoC Should Wait
Not all economists agree that the Bank of Canada should press ahead with rate cuts. Some argue that excess supply conditions could make it challenging to steer inflation to the target rate without undershooting. They caution that the central bank may not want to overdo it, as any relief could be temporary before hikes return.
Conclusion
In conclusion, the Bank of Canada’s expected rate cut is a response to the country’s economic weakness, which has been more pronounced than in the U.S. While some economists argue that the BoC should wait, the majority expect the central bank to cut rates and leave the door open for more easing. As markets react to the expected rate cuts, borrowers are already seeing modest improvements in interest costs. The Bank of Canada’s decision will be closely watched, and its impact on the economy and mortgage rates will be significant.
