Bank of Canada could cut rates before the end of 2023: economist

Rate cuts by the Bank of Canada may have seemed an unimaginable prosect over the past 12 months – but there’s a decent chance that the central bank could lower its benchmark rate by the end of 2023, according to a prominent economist.

Francis Gosselin (pictured), consulting economist for nesto, told Canadian Mortgage Professional that while the move was by no means a certainty, he expected the Bank to introduce a cut to that trendsetting interest rate, which heavily influences variable mortgage rates, before the year is out.

That would mark a significant step. Since last March, the Bank has hiked its rate eight times, bumping it by 425 basis points in a bid to stave off surging inflation and cool the Canadian economy.

That inflation has fallen decisively in recent months – coming in at 5.2% in February, compared with a 39-year high in June 2022 of 8.1% – and is likely to continue ticking downwards, Gosselin suggested.

“We’ve seen a continuous decrease in the inflation rates in Canada. Some goods and services like food… are still increasing. But a lot of other goods and services are stable,” he said. “It’s also interesting: a lot of the inflation that we are carrying right now is due to the increase in home mortgage payments that was the consequence of the policy rate’s increase.”

The mortgage-driven inflation from March, April, and May of last year will soon no longer factor in the year-over-year consumer price index (CPI) calculations, Gosselin said, meaning that overall inflation is likely to hit the central bank’s 2% target either by the end of 2023 or early 2024.

“And the Bank will not wait until we reach 2% before they start decreasing the policy rate,” he added. “They’re going to try to reach a soft landing, to not damage the economy too much with high rates while going towards the 2% [target].”

Former Bank of Canada governor Stephen Poloz has warned that the country is at greater risk of a “hard landing” than ever before.https://t.co/MnWfe9ZI4L#mortgage #mortgagenews #finance #federalbudget

— Canadian Mortgage Professional Magazine (@CMPmagazine) March 27, 2023

Could the US Fed force the Bank of Canada’s hand on rate hikes?

One possible wild card in assessing the Bank of Canada’s strategy for the remainder of the year: how things play out south of the border, with events in the US – and the policy pursued by its own central bank – potentially having huge repercussions for Canada.

Observers have noted the danger of the Bank of Canada diverging too far from the US Federal Reserve and causing significant damage to the loonie if it hits pause on rate increases while the Fed embarks on a rate-hiking rampage.

That would also have a knock-on effect on inflation in Canada, Gosselin said. “Too much of a difference between the policy rates of the Fed and the Bank of Canada will have the direct impact of changing the exchange rate, and in doing so it’s going to be great for our exporters,” he said.

“But for you and me, for consumers, that means that every product that we import from the US will be more expensive, so ergo inflation [will worsen]. So you don’t want to have too much of a gap between the rates. For sure Mr. Macklem [Tiff, the Bank of Canada’s governor] will be keeping an eye on the decisions that are being made on the other side of the border.”

Whether the Fed has further oversized hikes in mind remains to be seen – but even a 25-basis-point hike at its next meeting would reduce the likelihood of Bank of Canada rate cuts before the end of the year, according to Gosselin.

That said, with Fed chair Jerome Powell currently “under a lot of fire” and some of the effects still lingering from the chaos that gripped US financial markets in March, it might be worth taking any future aggressive language from the Fed with a pinch of salt.

“The language is important because it creates expectations, and in inflation there’s a very large dimension that is psychological,” Gosselin explained. “If you believe that prices will go up, you make prices go up by asking for increased wages, you [may be] willing to pay more for your house, because you believe things will go up. So it’s kind of self-fulfilling.

“Obviously, when the Fed has strong language saying that they will not budge, they’re basically sending a signal. I think this is a bit of lip service.”

Could surging oil prices prove problematic?

Another potential curveball is a recent spike in oil prices after the unexpected announcement last week that Saudi Arabia and other OPEC producers planned to reduce the amount of crude they send out monthly.

“That’s something that surprised a lot of people including myself,” Gosselin said. “Obviously energy is the lifeblood of the economy, and so if your energy prices go up, trucks have to pay more, so the food is more expensive and everything’s more expensive.

“So that’s going to be the wildcard. I don’t know where oil prices are going to go this year, and should they go up further, [that could put] pressure on prices and generating inflation. That could be a gamechanger, but it’s very difficult to forecast at this point.”