Recent market expectations have significantly shifted towards anticipating greater cuts by the Bank of Canada (BoC). Earlier this year, markets were projecting only a 0.25% reduction in interest rates for the entirety of 2024. However, with inflation consistently declining and signs of an economic slowdown becoming more evident, these expectations have now risen to 0.75%, with potential for further increases. The current market sentiment suggests that the BoC is likely to lower rates in its July and December meetings, with a pause anticipated in September and October.
However, a June 2024 Edge Realty Analytics analysis suggests that there could be rate cuts in every BoC meeting for the remainder of the year. By the fall, there may even be the possibility of a 0.5% reduction in the December meeting.
Source: Edge Realty Analytics
The Edge Realty initial forecasts earlier in the year of a 1.50% total reduction for the year may not be fully realized, but the market movements appear to be moving closer to these predictions. Notably, the 5-year bond yield has declined by 0.5% in June, and markets are already factoring in lower long-term rates extending beyond the next two years.
Two significant developments for those monitoring the BoC emerged this week:
1. Bank of Canada Unconcerned About Exchange Rate Fluctuations
The BoC’s recent release of the minutes from its interest rate deliberations provided valuable insights into the internal discussions of the Governing Council. A notable highlight is the BoC’s lack of concern over the implications of a weaker Canadian dollar. Despite recognizing that there are limits to how far Canada’s monetary policy can deviate from that of the US Federal Reserve, the minutes indicated that the council does not see these limits as a pressing issue yet.
Source: Edge Realty Analytics
Moreover, when identifying the top five risks of an unexpected inflation increase, a weaker exchange rate did not even make the list. This suggests that the BoC does not appear to view the weaker Canadian dollar as a significant constraint against implementing further rate cuts, which some economists believed would be a constraining factor.
2. Significant Reweighting of Mortgage Interest Costs in the CPI Basket
Also notable, Statistics Canada recently revised the weights in the Consumer Price Index (CPI) basket, with the most significant change being the substantial increase in the weight of mortgage interest costs, from 3.5% to 5.2%.
This change is particularly timely given the ongoing rise in the mortgage interest cost index, which currently contributes 0.7% to the headline CPI. With the BoC now on a path towards easing monetary policy, the increased weighting of mortgage interest costs in the CPI basket could lead to a more rapid decline in reported inflation. This adjustment effectively sets the stage for potentially weaker inflation readings later this year and throughout 2025, reinforcing the BoC’s confidence in the continuing downward trend of inflation.
In summary, the BoC is signaling more rate cuts without significant concern for the weaker Canadian dollar, while recent changes in the CPI basket composition could expedite the appearance of falling inflation, giving the Bank more room for maneuvering monetary policy.
Source: Edge Realty Analytics