Despite expectations of a cut, the upcoming BOC rate meeting could be a chance to add some strength to the Loonie. The Canadian currency has been falling against its southern counterpart all month, in anticipation of lower rates. But the central bank, in looking to steer a more stable course, is more likely to disappoint the doves.
There is a pretty solid consensus that the BOC will cut rates by 50 bps when its meeting ends on Wednesday. That would be the first “jumbo” rate cut in more than 15 years (outside of the pandemic), bringing back echoes of the sub-prime crisis. With inflation now back below target, the expectation is that the central bank will pull out all the stops to support the flagging economy.
How Low Can You Go?
The expected rate cut would put the benchmark interest back to 3.75%, down from the 5.0% that had been maintained for about a year before the cutting cycle began. Markets are particularly interested in the BOC, because it often “leads” the Fed, as the smaller country can notice economic shifts sooner. With the market now back to expecting the Fed will cut at a more modest pace of just a quarter of a point per meeting, the move by the BOC would be expected to widen the interest rate gap between the countries.
In terms of the market reaction, it’s pretty hard for the BOC to be more dovish than the market is already pricing in. But it is fairly easy to be slightly more hawkish. At the last meeting, Governor Tiff Macklem suggested that steeper cuts were definitely a possibility, and the market reacted in course. But, aside from outright saying that there will be a “double” rate cut in December, the BOC has little option to be more dovish. Just reiterating a stance that more easing will be needed and the bank will make its decision based on the data would likely be interpreted as more hawkish than the market outlook.
So, A Rebound in the Loonie?
Markets are pricing in a 76% chance of a 50 bps cut, followed by a 25 bps cut in December. That is in line with a large majority of economists. The projections are based on inflation falling to 1.6% in September and an advance reading for August GDP showing nill growth (well below the BOC’s projections of 2.8% annualized growth in the third quarter).
That does provide some wiggle room, particularly if the BOC sticks to its guns with regards to its growth forecasts. The market reaction could come down to the language in the monetary policy statement, and the accompanying press conference. Traders might be looking to weigh how much importance the BOC is putting on supporting the economy, and whether a rebound is expected later in the year, thanks to easing interest rates both in Canada and the US.
Setting Expectations in Order
There is a counterpoint to this view, which is that despite the easing so far, consumer and business spending has not picked up, and the housing market remains stagnant. Interest rates are likely still in restrictive territory, which could justify further cuts in the short term, at least until the economic data starts to turn around.
The thing is, the recent slowdown in the economy and inflation has caught the BOC by surprise. Real interest rates (that is, factoring in inflation) are still relatively higher than other advanced economies because of lower inflation. That could leave the BOC scrambling to ‘catch up’ to the shifting economic situation.
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