Is it too early to discuss Bank of Canada rate cuts?

Central bank is maintaining a somewhat hawkish tone, 'even if no-one believes them,' says BMO chief economist Porter

Is it too early to discuss Bank of Canada rate cuts?

The Bank of Canada’s decision to leave rates unchanged on Wednesday was an unsurprising one – but its continuing indication of a willingness to raise rates means it’s “probably premature” to discuss cuts at present.

That’s according to Bank of Montreal (BMO) chief economist Doug Porter (pictured), who told Canadian Mortgage Professional that the central bank appears keen to pour cold water on the idea that it’s finished with rate hikes despite increasing certainty from financial markets.

“The fact that they kept rates unchanged was absolutely expected, but we also thought they would still talk about the possibility of rate hikes, even if no-one believes them,” Porter said. “They’re still talking relatively tough. They’re still warning that... talking about rate cuts is probably premature at this point.

“But again, the market – and it’s not just here in Canada, it’s true in the US and for some other markets as well – has become absolutely convinced that rate cuts are almost imminent. If they’re not going to happen at the next meeting, it might be at the meeting after that, or at the very latest, the meeting after that.”

BMO is taking a more cautious view on the imminence of rate cuts – but the Bank’s language is clearly geared towards tamping down some of that market enthusiasm, Porter said, as it bids to continue bringing inflation towards its 2% target.

Good news on that front arrived on Wednesday with oil prices, a strong contributor to sticky inflation in recent months, dropping below $70 (US) a barrel in a development that could strengthen the case for rate cuts.

“The fact that energy prices are really helping out here by moderating rapidly, that helps bring down headline inflation,” Porter said. “I think it helps chip away inflation expectations. So that’s really helping the argument for interest rates to eventually come down.”

Could the Bank of Canada cut rates before it hits the 2% inflation target?

While the Bank remains steadfast in its intention to bring Canada’s inflation rate down to 2.0% on the dot, Porter said it has “some leeway” to start cutting at a slightly higher rate if inflation expectations back down sufficiently.

The first number before the decimal point should be a two before the Bank begins to trim rates, he added – but it’s unlikely to ease back significantly on its target to continue lowering inflation.

The inflation rate has plummeted from a 39-year high in June last year of 8.1% to its current level of 3.1%, with oil prices also ticking down. So why is the Bank still so concerned about bringing it down even further?

Resilient wage growth is a big part of the reason the central bank still has its eye focused squarely on the inflation rate, according to Porter.

“They said in the statement that wages are still growing by 4% to 5%, and we’ve got no productivity growth in this economy,” he said. “And so when you’ve got wages growing 4% to 5%, that sets a pretty high bar for inflation. That almost locks in a fair bit of inflation over the next year – and essentially, that’s why the Bank is still concerned.”

How much will the Bank of Canada cut interest rates by in 2024?

Much has been made in recent months of the impending wave of mortgage renewals set to hit the market in 2024 and 2025, with borrowers who took out a mortgage at the record-low rates of the COVID-19 pandemic likely to see renewal at far higher rates when their original term expires.

For many observers, that makes the need for Bank of Canada rate cuts next year and the following all the more essential.

“I do believe they have to come down by at least 100 basis points,” Porter said. “It won’t necessarily all happen in 2024. Some of that might happen in 2025. Our view is that they’re going to come down more than that by the time we get into late 2025.

“But look: 2025 is still a long ways away, and a lot can happen between here and there. It’s possible that for other reasons, interest rates might have to come down further. We think they’re not going to be rushed in cutting rates, so we think this will be a fairly slow process on the way down the staircase.”

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