(Bloomberg) -- The Bank of Canada is ready to pivot. The only question is when it will act.
It’s becoming clear that Canada’s economy no longer needs restrictive interest rates. But for a cautious Governor Tiff Macklem and his policymakers, the decision between cutting on Wednesday or on July 24 will depend on how certain they are that inflation is under control.
The bank’s credibility is at stake. Faulty output gap and inflation forecasts led to a delayed start to rate hikes in 2022. Officials need to be confident that price pressures won’t reignite after they start lowering borrowing costs. Cutting prematurely, only to reverse course and hike again, would strike a major blow to public confidence in the institution.
Still, conditions appear ripe for a cut. Growth in gross domestic product has been below potential for a year, and there’s mounting evidence that inflation – which hit 2.7% in April – is sustainably headed to the 2% target. Most analysts in a Bloomberg survey expect a cut Wednesday, though Canada’s six biggest lenders are split. Markets put the odds at over three-quarters.
“If they want to cut, they have all the pieces they need now,” Andrew Kelvin, head of Canadian and global rates strategy at TD Securities, said in an interview. He expects a cut Wednesday, changing his call after first-quarter GDP data surprised to the downside last week.
The Bank of Canada’s meeting comes a day before the European Central Bank is widely expected to lower borrowing costs, so the northern nation could become the first in the Group of Seven to launch into an easing cycle. European officials have more clearly telegraphed a rate cut is coming, however. If Macklem holds this week, he’s likely to signal that a cut is imminent.
A cut in the policy rate from 5% this week would mean the Bank of Canada is moving well before the Federal Reserve. Historically, the countries’ interest rates have tended to take a similar path, and when they don’t, there’s some pressure on the currency. A weak loonie means higher import costs, risking higher inflation. Macklem has said there are limits to how much his central bank can diverge from its US counterpart.
“They might as well wait and see a bit more evidence,” Veronica Clark, an economist with Citigroup, said in an interview. “The US experience should probably be a pretty cautionary tale — we had six to seven months of core inflation that was right around target and it came back.”
In Canada, the consumer price index rose at a 2.9% yearly pace in the first quarter, in line with the central bank’s projections. Core measures have continued to decelerate and the labor market is loosening. Still, inflation has been above 3%, the cap of the Bank of Canada’s operational target band, for 32 of the past 37 months.
Importantly, there are questions about lingering economic momentum. Domestic demand rose at a 2.9% annualized pace in the first quarter, and preliminary data show GDP growth tracking 0.3% in April. At the same time, record immigration-driven population gains have made it harder for the bank to read underlying momentum in consumption and inflation.
What Bloomberg Economics Says...
“Even after inflation surprised to the downside in the first three months of the year, the Bank of Canada can wait to cut rates. Growth accelerated on a quarterly basis in 1Q, and preliminary estimates show economic activity and retail sales improving to start 2Q.”
— Stuart Paul, US and Canada economist
Read the full report here.
Canadians are holding up better than expected amid one of the fastest run-ups in borrowing costs in the history of the central bank. Canadian households carry some of the largest debt burdens in advanced countries, and while that’s working to slow consumption spending, mortgage defaults remain low. The mortgage delinquency rate was just 0.17% in the fourth quarter of 2023, up from 0.14% in the third quarter of 2022, according to the Canada Mortgage & Housing Corp.
But it’s unclear how households will fare over the next two years as a growing proportion renew their mortgages at higher rates than before. For some analysts, that’s an important argument for the Bank of Canada to start normalizing monetary policy this week.
“A lot of people will have to make material changes to their spending habits to be able to service their mortgage debt,” Royce Mendes, managing director at Desjardins Securities, said in an interview. “If the bank is too slow to adjust rates, you could force the economy into an unnecessary recession.”
Waiting for July would allow the bank to outline its plan more clearly in the form of a monetary policy report, which would contain fresh forecasts for inflation and the economy.
Another question is how policymakers communicate the pace at which they’ll lower borrowing costs. In their most recent summary of deliberations for the April meeting, they indicated they’d move gradually.
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