Bank of Canada sets the stage for more rate cuts

In line with market expectations, the Bank of Canada today cut its overnight rate target by 25 basis points, to 4.50%. The accompanying media release, together with an updated Monetary Policy Report (MPR), provide detailed insight into the Bank's current thinking. 

The Bank estimates that GDP growth picked up to 1.5 percent at an annualized rate in the first half of this year. However, this remains well below the immigration-driven level of growth in population and the labour force, which has two important implications. First, per capita GDP -- living standards, if you like -- is falling; second, the economy is moving into a situation of excess supply, which should help to reduce inflationary pressures. The Bank projects real GDP growth of 2.1 percent in 2025 and 2.4 percent in 2026, which should gradually eat into the current excess supply. 

The Bank believes that "broad inflationary pressures are easing". It bases this view on the recent decline in headline CPI growth, as well as the fact that its preferred measures of core inflation are all now running below 3 percent. However, it notes continuing upward pressure from shelter costs, as well as for services, where wage pressures are a significant contributor.

The Bank's analysis of wage pressures is slightly puzzling. In the media release it states that "wage growth is showing some signs of moderating, but remains elevated".  A trawl through the MPR reveals a graph (on page 16) that seems to support the second of those assertions but not the first. Data from the widely-followed Labour Force Survey clearly show continuing acceleration in wage growth, although series from the less well-known SEPH* series (which are also less up-to-date) may just possibly be showing signs of the desired moderation.

The Bank warns that the path of CPI in the coming months may be hard to interpret. It expects headline CPI to slip below the core measures as a result of base effects for gasoline prices, but warns the headline number may then pick up again before "settling around the 2 percent target next year". 

This outlook seems to support the likelihood of further rate cuts before year end, though as ever the Bank cautions that its decisions will be data-driven. The next Governing Council meeting is just six weeks away, on September 4, meaning the Bank will only have one more print of each of the two main series it follows -- CPI and employment -- before it makes its next rate decision.  It seems as if the Bank would like to front-load the easing cycle as long as the data allow it. Two more rate cuts are all but certain by year-end, and there could be more than that. 

* Survey of Employment, Payrolls and Hours