‘Very strong case’ for Bank of Canada cut this week, if inflation data co-operates

The head office of the Bank of Canada located at 234 Wellington Street in Ottawa. Photo by Adam Huras/Brunswick News

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Economists and markets are expecting the Bank of Canada to cut its policy rate by a quarter point on Wednesday, barring any major surprises in the inflation data set to be released the day before.

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“I think they have a very strong case to cut interest rates,” said Jimmy Jean, chief economist at Desjardins Group.

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Jean said the market odds of a cut on Wednesday have jumped to 90 per cent, supported by recent data that shows an economy grappling with weak growth and a deteriorating labour market.

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Canada’s economy entered a contraction in the second quarter of this year, with gross domestic product falling by 1.6 per cent, a steeper decline than what economists were expecting. Canada’s labour market also lost 100,000 jobs in July and August and the jobless rate jumped to 7.1 per cent last month, a nine-year high outside of the pandemic.

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The Bank of Canada has held its policy rate at 2.75 per cent at three of its last decisions, amid trade uncertainty with the United States and evidence of underlying inflation. While Canada’s headline inflation remained below two per cent in July, core inflation remains elevated around three per cent.

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At the bank’s last rate decision in July, Bank of Canada governor Tiff Macklem left the door open for further rate cuts, if there was evidence that inflation remains contained.

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“If a weakening economy puts further downward pressure on inflation and the upward price pressures from trade disruptions are contained, there may be a need for a reduction in the policy interest rate,” Macklem said on July 30.

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Porter said the softness in the job market and the housing market will ultimately weigh on underlying inflation.

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Jean said the removal of the counter tariffs on U.S. goods will also give further confidence for the Bank of Canada when it comes to concerns about an inflationary spiral or a stagflation scenario.

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“I think that was the main thing that was bugging the Bank of Canada with inflation, and I think we got some pretty good news in the last month,” said Jean. “Even if it were to overshoot a little bit, I don’t think it would derail the broad thinking about inflation risks.”

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Still, some economists remain skeptical that a cut is a done deal.

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Royal Bank of Canada economists Nathan Janzen and Claire Fan said the economic data has deteriorated but no more than what the central bank was expecting.

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“We look for the central bank to narrowly opt for a hold on interest rates,” they said in a note. “Although, that will also depend on the August consumer price data out on Tuesday.”

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Looking forward, Porter said BMO expects the central bank to deliver more easing, with the policy rate ultimately landing below the neutral range at two per cent by the beginning of next year.

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“It’s very rare for the bank to do solo rate moves, so we think there will be more,” he said.

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