The Bank of Canada lowered its benchmark interest rate by half-a-percentage point to 3.75%, citing greater confidence in its efforts to lower inflation. Francis Fong, Senior Economist at TD, speaks with MoneyTalk’s Anthony Okolie about the latest decision, the state of the economy, and the path forward for rates.
Print Transcript
* The Bank of Canada has delivered a jumbo-sized 50-basis-point rate cut today. Joining me now to discuss the decision is Francis Fong, Senior Economist with TD. And, Francis, heading into this, there was a lot of uncertainty, whether it's going to be 50 or 25. Did the decision ultimately surprise you?
* Yeah. This was, obviously, a tough one, Anthony. I think if you look at the underlying data of what the Bank of Canada was walking into this meeting with, there were signals, I think, where you could argue in favor of a larger rate cut, as they ultimately did, or, perhaps, the size of cut that we've seen in the past couple of meetings, which is just the regular 25-basis-point cut-- things like inflation, where headline inflation is already back to target, but core inflation is still rising a little bit above that.
* We have the unemployment rate at 6.5%. I think you could argue that that's a certain amount of weakness that might call for a larger cut. But we also see things like wage growth that is still running pretty hot. Unemployment rate, in terms of absolute terms, falling. Job growth, that's still pretty decent.
* And so our call was for a 25-basis-point cut. But, ultimately, the bank just decided to characterize that economic framework as being justified for a relatively larger cut, so not a huge surprise, but, certainly, I think, a surprise in terms of where they were relative to their forecast.
* They had a fairly strong forecast heading into the last monetary policy report that they released. And, yet, they decided this time that they would characterize that as weakness justifying a larger cut.
* Yeah. And I want to talk a little bit about their statement today because they talked about the softness of the labor market. Do you think we can expect another jumbo-sized rate cut in December?
* Yeah, I think that's going to be top of mind for a lot of folks right now. I think it's important to characterize that this 50-basis-point cut is the odd man out of the larger cutting framework that we've seen from the bank because we've already seen them do several 25-basis-point cuts. And then all of a sudden, right in the middle, we have this larger 50-basis-point cut.
* Does that justify further jumbo-size rate cuts? We would argue no, simply because this does sort of represent the odd man out are the cuts. Given where the overnight rate is right now and given where their forecast is, certainly with this updated forecast that they just released, they do have core inflation getting back to target by the end of next year, which would argue, I think, maybe a more consistent pace of rate cuts that would bring them back to neutral territory by the end of that point. So I think we would largely call for 25-basis-point cuts interspersed with some breaks, getting back to neutral by the end of next year.
* OK. Let's talk a little bit about the loonie because it has lost a bit of momentum after this decision. How do you expect it to perform going forward?
* Yeah, the CAD is definitely a bit of a tough one these days. With oil where it is, you would anticipate some movement there. And yet, we've seen almost no movement going around. And I think that's largely because markets are sort of depending on rate differentials between Canada and the US to tell that story.
* So given where pricing was heading into this meeting, you had equal-ish bets betting on a smaller rate cut versus the larger rate cut, and then, ultimately, the larger rate cut winning out. We did see that small correction kind of heading into the day. But, that being said, I think where market pricing is right now for the Bank of Canada is sort of-- moderate that pace of rate cuts going forward and let the Fed catch up-- that rate differential story sort of evens out. And so we anticipate the CAD to strengthen mildly, I will put it, mildly, from here on out, but to a point where we're not really going to see too much CAD strength, I think, over the medium term.
* Now, I want to talk a little about the risks to the Bank of Canada because we have seen this 50-basis-point jumbo-sized rate cut. Do you see any risk of inflation re-accelerating or even the housing market reheating after this latest rate cut by the Bank of Canada?
* It's a good question. And I think I might characterize it slightly differently in the sense that if we look at where inflation is today, a lot of the components that were driving inflation are either weak or turning. So we have things like gasoline prices, food prices, and a lot of other core spending that is, at this point, in negative territory, so in deflationary territory, at least on a year-over-year basis, whereas things like ownership costs, rent-- those have started to either peak or are starting to come down.
* So I think at this point, the bank is looking at that trajectory and thinking, well, we no longer need interest rates to be in as restrictive territory as we've seen, hence the jumbo rate cut that we saw today. So I don't anticipate inflation will all of a sudden reverse. That being said, it certainly is a risk if we do see growth pick up, but that's not really in the forecast.
* From the housing market's perspective, I would characterize it in a slightly different way in that we've seen sales activity essentially flatline over the past little while. But prices haven't really come down all that much. So to the extent that we do start to see sales activity, I would anticipate that given that we've already seen a correction in mortgage rates, and this rate cut will sort of just continue to spread that on.
* And so we would anticipate sales activity to pick up a little bit. From a price perspective, I think there's a little bit of catching up to do for sales to translate into that higher price activity.
* OK, and going forward, what are the indicators that you'll be watching closely as the Bank of Canada considers its next move?
* I think it's a little boring to say this, but, ultimately, we're going to be looking at those basics. We're going to be looking at where the labor market is headed, how the inflation data comes in, and how that performs relative to their forecast. They obviously update every once in a while.
* And every time we see a new forecast, how they've updated it, how the updated data moves relative to that will justify certain-sized rate cuts. But at this point, given where they're anticipating and where we're anticipating the Canadian economy to go, I would continue to anticipate that sort of moderate pace of rate cuts going back to neutral going forward.
* Francis, thanks very much for your time.
* Always a pleasure, Anthony.
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* Yeah. This was, obviously, a tough one, Anthony. I think if you look at the underlying data of what the Bank of Canada was walking into this meeting with, there were signals, I think, where you could argue in favor of a larger rate cut, as they ultimately did, or, perhaps, the size of cut that we've seen in the past couple of meetings, which is just the regular 25-basis-point cut-- things like inflation, where headline inflation is already back to target, but core inflation is still rising a little bit above that.
* We have the unemployment rate at 6.5%. I think you could argue that that's a certain amount of weakness that might call for a larger cut. But we also see things like wage growth that is still running pretty hot. Unemployment rate, in terms of absolute terms, falling. Job growth, that's still pretty decent.
* And so our call was for a 25-basis-point cut. But, ultimately, the bank just decided to characterize that economic framework as being justified for a relatively larger cut, so not a huge surprise, but, certainly, I think, a surprise in terms of where they were relative to their forecast.
* They had a fairly strong forecast heading into the last monetary policy report that they released. And, yet, they decided this time that they would characterize that as weakness justifying a larger cut.
* Yeah. And I want to talk a little bit about their statement today because they talked about the softness of the labor market. Do you think we can expect another jumbo-sized rate cut in December?
* Yeah, I think that's going to be top of mind for a lot of folks right now. I think it's important to characterize that this 50-basis-point cut is the odd man out of the larger cutting framework that we've seen from the bank because we've already seen them do several 25-basis-point cuts. And then all of a sudden, right in the middle, we have this larger 50-basis-point cut.
* Does that justify further jumbo-size rate cuts? We would argue no, simply because this does sort of represent the odd man out are the cuts. Given where the overnight rate is right now and given where their forecast is, certainly with this updated forecast that they just released, they do have core inflation getting back to target by the end of next year, which would argue, I think, maybe a more consistent pace of rate cuts that would bring them back to neutral territory by the end of that point. So I think we would largely call for 25-basis-point cuts interspersed with some breaks, getting back to neutral by the end of next year.
* OK. Let's talk a little bit about the loonie because it has lost a bit of momentum after this decision. How do you expect it to perform going forward?
* Yeah, the CAD is definitely a bit of a tough one these days. With oil where it is, you would anticipate some movement there. And yet, we've seen almost no movement going around. And I think that's largely because markets are sort of depending on rate differentials between Canada and the US to tell that story.
* So given where pricing was heading into this meeting, you had equal-ish bets betting on a smaller rate cut versus the larger rate cut, and then, ultimately, the larger rate cut winning out. We did see that small correction kind of heading into the day. But, that being said, I think where market pricing is right now for the Bank of Canada is sort of-- moderate that pace of rate cuts going forward and let the Fed catch up-- that rate differential story sort of evens out. And so we anticipate the CAD to strengthen mildly, I will put it, mildly, from here on out, but to a point where we're not really going to see too much CAD strength, I think, over the medium term.
* Now, I want to talk a little about the risks to the Bank of Canada because we have seen this 50-basis-point jumbo-sized rate cut. Do you see any risk of inflation re-accelerating or even the housing market reheating after this latest rate cut by the Bank of Canada?
* It's a good question. And I think I might characterize it slightly differently in the sense that if we look at where inflation is today, a lot of the components that were driving inflation are either weak or turning. So we have things like gasoline prices, food prices, and a lot of other core spending that is, at this point, in negative territory, so in deflationary territory, at least on a year-over-year basis, whereas things like ownership costs, rent-- those have started to either peak or are starting to come down.
* So I think at this point, the bank is looking at that trajectory and thinking, well, we no longer need interest rates to be in as restrictive territory as we've seen, hence the jumbo rate cut that we saw today. So I don't anticipate inflation will all of a sudden reverse. That being said, it certainly is a risk if we do see growth pick up, but that's not really in the forecast.
* From the housing market's perspective, I would characterize it in a slightly different way in that we've seen sales activity essentially flatline over the past little while. But prices haven't really come down all that much. So to the extent that we do start to see sales activity, I would anticipate that given that we've already seen a correction in mortgage rates, and this rate cut will sort of just continue to spread that on.
* And so we would anticipate sales activity to pick up a little bit. From a price perspective, I think there's a little bit of catching up to do for sales to translate into that higher price activity.
* OK, and going forward, what are the indicators that you'll be watching closely as the Bank of Canada considers its next move?
* I think it's a little boring to say this, but, ultimately, we're going to be looking at those basics. We're going to be looking at where the labor market is headed, how the inflation data comes in, and how that performs relative to their forecast. They obviously update every once in a while.
* And every time we see a new forecast, how they've updated it, how the updated data moves relative to that will justify certain-sized rate cuts. But at this point, given where they're anticipating and where we're anticipating the Canadian economy to go, I would continue to anticipate that sort of moderate pace of rate cuts going back to neutral going forward.
* Francis, thanks very much for your time.
* Always a pleasure, Anthony.
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