Ca reaction: BoC holds policy, but clears obstacles to a cut

The Bank of Canada (BoC) left its key overnight policy rate unchanged at 5.00% for the fifth consecutive meeting (since July 2023), also leaving Bank Rate unchanged at 5.25%. The Boc also said that it would continue with its quantitative tightening (QT) programme. This was in line with ours and broader market forecasts. However, with the market expecting the BoC to ease at its next meeting on 5 June all eyes were on the outlook for when the BoC might start to ease policy.

The BoC published its quarterly Monetary Policy Report (MPR) alongside today’s meeting. In it, it raised its outlook for Canadian GDP growth to 1.5% in 2024 (from 0.8%) and 2.2% in 2025 (from 2.4%) and 1.9% (for 2026). This was driven by three main factors. US economic activity was now expected to be stronger than before, the BoC lifting its Us forecast to 2.7% (from 1.7%) for this year and 1.8% (from 1.2%) in 2025. More domestically, the BoC acknowledged the impact of rising population growth. It stated that faster than expected population growth had led it raise its trend growth estimate this year by 0.4% (to 2.1-2.8%), but following the government announcement that it would limit temporary workers more next year it lowered its outlook by 0.3% (to 1.1-2.4%) for next. Finally, the BoC expects a recovery in household spending. Given this growth outlook, the BoC had stated that it saw the economy as having moved into excess supply in H2 2023, and likely to remain so in 2024, before absorbing slack in the economy over the coming two years.

Excess supply in the economy should be expected to deliver softer inflation and BoC’s MPR opened saying that “Core inflation is also coming down, although risks remains and it will take more time to see if this progress proves durable”. It added that “disinflation becoming more broad-based“ with “progress on most indicators of underlying inflation”. Indeed the report concluded that “inflation pressures [were] easing somewhat faster than anticipated in January”. While more generally it explained that labour conditions had begun to ease and wages to moderate. The BoC also appeared to have gained confidence from its latest business survey showing an easing in corporate pricing decisions, recording fewer firms planning price hikes and a reduced frequency of price changes. Overall, the BoC lowered its inflation forecast to 2.6% for 2024 (from 2.8%) and left 2025 unchanged 2.2% (2.2%). This is closer to our own view of 2.3% this year and 2.2% next. However, despite this improvement, the report showed that more than 50% of services items saw inflation still over 3%; with goods around one-third. It also acknowledged risks from geopolitical developments.   

In concluding, the BoC’s accompanying statement shifted the emphasis of its guidance. In March, the Committee continued to warn about concerns of “underlying inflation persistence”. In contrast, April’s statement noted that “CPI and core inflation have eased further in recent months” and although it stated the Council sought evidence that “downward momentum is sustained” it did not specifically warn of “persistence”. Moreover, while March had warned explicitly that it was “too early to loosen the restrictive policy that has gotten us this far”, no such warning was present this time. The Committee seems to have cleared the way to announce an easing in monetary policy and it simply remains to decide when to cut rates.

The Committee will see two more inflation and GDP prints before its next meeting. While we expect headline to come in a little softer than the BoC expect this year, the near term headline is likely to be driven by developments in oil prices, while the BoC will pay more attention to core pricing. The Boc has clearly seen improvement in core inflation trends. However, we think a combination of strong GDP growth (the BoC expects a 2.8% annualised growth rate in Q1), yet a still weak Canadian dollar (as expectations for a Fed policy cut move further back) will additionally influence the BoC. While we acknowledge that the BoC could lower its policy rate in June, as markets have more recently believed, we maintain our outlook for a July cut. We also keep our expectations for three cuts over the remainder of this year – to 4.25%. This is now market consensus, despite markets pricing over twice this number of cuts four months ago. We also continue to see three cuts next year (to 3.50%), again now consensus with markets having considered and end-2025 rate of 2.75% at the end of 2023.

It is also worth noting that at this point in the year, the BoC reviews its assessment of the neutral rate. This year it increased that outlook by 0.25% (to 2.25-3.25%). It stated that this reflected both developments in the Canadian economy – particularly faster population growth – and a rise in the US neutral rate.  

Canadian financial markets saw additional volatility as they reacted to the US CPI release before the BoC announcement. Market expectations for a June cut dropped from 84% before the US CPI release to just 50% before the BoC announcement before settling around 60% now. Similarly expectations for year-end rates shifted from more than three cuts to less than 50% chance for three cuts before the BoC meeting to currently trade around a 75% chance of three cuts. 2-year and 10-year GoC bond yields were equally volatile, yields rising by 15bps and 13bps respectively after CPI, to retrace 3bps and 2bps after the BoC, to 4.30% and 3.65% respectively. The Canadian dollar had dropped 0.8% to the US dollar at the time of writing, taking it to $1.3668 and its weakest since November.