Canadian inflation dynamics favour early rate cut
The Bank of Canada (BoC) can cut interest rates independently of the US Federal Reserve, even if the Fed holds rates steady, TD Bank said in its latest economic outlook.
According to the bank, the Canadian economy has been growing below its trend rate for nearly two years, leading to a relative easing of inflation compared to the US. This divergence in economic conditions allows the BoC to respond to domestic factors, such as subdued inflation, and pursue an independent monetary policy.
"If the BoC believes that it has curbed economic growth enough to ensure inflation is on a sustainable path back to 2%, it should cut rates – even if the Fed doesn't," the bank wrote in a Q&A blog post.
The bank argued that if the BoC believes it has done enough to bring inflation sustainably back to the 2% target, it should cut rates, regardless of whether the Fed cuts or not.
"The pertinent question is not 'if' the BoC can cut ahead of the Fed, but by 'how much'," TD Bank said. Historically, a 100 to 125 basis point policy rate spread between the Fed and BoC is sustainable without excessively weakening the Canadian dollar.
While the exact timing of a BoC rate cut remains uncertain, TD Bank predicts it could happen as early as July. This would create a widening gap between Canadian and US interest rates, potentially impacting various sectors of the economy, including the housing market.
Impact of government budgets on BoC's efforts
The report also addressed concerns about recent government spending. TD said that recent federal and provincial budgets have made the BoC's job harder.
"The plans outlined by governments in the 2024 budget season reflect net outlays running faster than economic growth, which can work against the Bank of Canada's efforts to fight inflation," the bank said.
However, the impact on growth is expected to be less than in previous years. The bank estimates the combined impact of recent federal and provincial budgets will provide only a modest 0.2 percentage point boost to Canadian GDP growth this year due to tax and spending measures, primarily from the provinces.
"The fillip to growth is less than in recent years," TD said, noting fiscal measures in 2023 had added around 0.9 percentage points to growth.
New policies and the housing market
Regarding the housing market, TD does not foresee significant changes from recent federal and provincial policies.
The government’s initiatives to increase housing supply, especially in the purpose-built rental space, are expected to have only a marginal impact.
Demand-side measures, such as the federal government's decision to lengthen amortizations from 25 to 30 years for first-time homebuyers with insured mortgages, are also unlikely to significantly alter resale forecasts.
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“Government ambitions to boost housing supply are a tall order,” TD said. “They face challenges presented by labour constraints: an aging workforce, recent newcomers to Canada are working in construction at a lesser rate than in major sectors, according to a Bank of Canada analysis, and competition for workers from non-residential projects.”
The federal housing plan's target of 550,000 new housing units per year is more than double the historic maximum.
At the provincial level, notable measures include more funding for purpose-built rental construction in British Columbia and infrastructure projects in Ontario. However, these efforts are expected to face similar constraints as the federal plan.
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