Could the Bank of Canada reduce interest rates in 2023?

Murky economic waters may be ahead after recent banking turmoil in the US

Could the Bank of Canada reduce interest rates in 2023?

Just days after the Bank of Canada announced no change to its benchmark lending rate in March, turmoil gripped global financial markets as the collapse of two major US institutions raised questions about the stability of the banking sector.

The impact of the toppling of Silicon Valley Bank and Signature Bank continues to be keenly felt, and helped jolt the US Federal Reserve towards a more dovish approach than had been expected in its own rate decision last month.

It also sparked speculation that Canada’s central bank could be set to push forward its own timeline for rate cuts in a bid to stave off economic panic as fears grew of a possible contagion effect.

Odds of an April rate cut surged as the chaos continued, although that prospect appears to have receded in recent weeks – with the Bank only likely to make a move in 2024 at the earliest, according to CIBC Capital Markets chief economist Avery Shenfeld.

Indeed, lessons learned from previous mistakes suggest that the central bank will take a cautious approach to rate cuts, a leading commercial broker in the Pineapple network told Canadian Mortgage Professional.

Anne Ananda (pictured) said that the Bank will be mindful of past inflation trends in the wake of rate cuts when weighing up its next move.

“In the past when [the Bank of Canada] raised rates in order to reduce inflation, once inflation was back at the target range it quickly reduced the rates,” she said. “The last two times it did that, inflation crept back up quite quickly. The Bank of Canada will not make the same mistake this time.”

How quickly – and by how much – might the Bank of Canada cut rates?

Even if inflation returns to the central bank’s target level quickly, Ananda said she believed it would maintain its current trendsetting interest rate for eight to 12 months to ensure that further inflation is definitely out of the question.

What’s more, there’s little to no chance of rates falling dramatically, with a measured and cautious approach likely to be the order of the day, according to Ananda.

“Let’s not kid ourselves on how much the rates are going to reduce,” she said. “An overnight lending rate close to zero is not even close to normal… When and if the rates come down, nobody should expect them to come back down anywhere near to what they were. I believe that a normal interest rate in today’s market is more or less 100 basis points less than what we currently have.”

What impact will the US Federal Reserve have on Canada interest rates?

Federal Reserve chairman Jerome Powell tempered his bellicose language on interest rates as the current crisis took root, having previously indicated that he was prepared to introduce further oversized hikes to combat rampant inflation.

While the decision to move by just 25 basis points in March reflected the uncertain economic landscape, it remains to be seen whether the Fed will return to the combative approach outlined by Powell when (or if) the current crisis abates.

That could have big consequences for Canada – especially if the US central bank begins to ramp up rates at a time when the Bank of Canada has decided to leave its own rate untouched, Ananda said.

“Up until the collapse of a few banks recently in the US, the Fed had clearly indicated that it was going to go on a tear raising its rates,” she sad. “If the US were to raise its rates significantly over the next 12 to 24 months, this would eventually have a very negative effect on the value of the Canadian dollar.

“Should that happen, the Bank of Canada’s only tool in order to prop up the dollar would be to match the rising rates in the US.”

That said, lingering unease about the future of financial markets means it looks more likely that the Fed will hold fire on oversized rate increases for now, a development that would be welcome news for the Bank of Canada and the Canadian economy.

“We understand that the Fed will likely hold back on its program to raise rates and this will give the folks north of the border a little bit of respite in hope that the rates in Canada will likely stay low for the foreseeable future,” Ananda said, “and will likely not be affected as much by the Fed rate.”

What are your thoughts on the Bank of Canada’s likely strategy in the weeks and months ahead? Let us know in the comments section below.