Bank of Canada will be closely watching how the Fed acts in the coming months, says economist
The Bank of Canada is likely gearing up for another interest rate cut in July – but its longer-term plans for rate reductions could be closely tied to the US Federal Reserve’s approach, according to CIBC’s Benjamin Tal (pictured).
The deputy chief economist told Canadian Mortgage Professional in the wake of the central bank’s decision to reduce interest rates by 25 basis points on Wednesday (June 5) that it appeared in a mood to cut again at its next rate announcement, barring unforeseen developments.
“From their language, it seems that the Bank of Canada is still expecting inflation to ease [further] – and that’s exactly what they’re pointing to,” he said. “So although they’re telling you that it’s meeting by meeting, I think what they have in mind now is another cut in July.
“I think it’s very reasonable to [expect] three, maybe four rate cuts by December. That’s a reasonable guess at this point. The key issue is really not Canada – the key issue is the US.”
The central bank’s first cut for over four years had been accompanied by an unexpectedly “dovish” statement suggesting it could be prepared to bring rates lower again next month, according to BMO chief economist Doug Porter.https://t.co/O7yeQrToBw
— Canadian Mortgage Professional Magazine (@CMPmagazine) June 6, 2024
Canadian and US economies posting markedly different performances
The central bank’s cut last week, which saw its benchmark rate drop to 4.75%, arrived with inflation having fallen within its target range of 1-3% for each of the last four months, and core inflation figures trending resolutely downward.
First-quarter gross domestic product (GDP) figures also came in milder than expected – but the economy south of the border is posting a much more resilient performance, with stronger GDP data, a more robust labour market, and stubborn inflation persisting in the US.
That means the US economy is likely to factor heavily in the Bank of Canada’s approach as it weighs up its moves for the rest of the year, according to Tal.
“The US is surprising on the upside. Inflation there is not easing as quickly. GDP is much stronger. The labour market is stronger. So the question that I think every person who is interested in interest rates should ask themselves is to what extent the Bank of Canada can divorce itself from the Fed,” he said.
The largest possible spread between the Fed and Bank of Canada policy rates without the risk of currency weakening is around 100 basis points, Tal said, with the current difference (50 basis points) meaning the Canadian central bank could likely move a further 50 points below the Fed without causing any issues for the loonie.
“But the minute you go beyond that and you continue to cut while the Fed is neutral, you put downward pressure on the Canadian dollar, which is inflationary,” he said. “That’s something the Bank of Canada would like to avoid.
“So the big test will not be this move, and not the next move, but after that if the Fed does not move. And that’s not an unthinkable scenario. I think the market now is realizing that the Bank of Canada will move faster and more aggressively than the Fed.”
How will the housing market react to the Bank’s rate cut?
While Wednesday’s decision marked the first time the Bank of Canada has cut its benchmark rate since the beginning of the COVID-19 pandemic, Tal suggested it’s unlikely to lead to an immediate uptick in homebuying activity and prices.
“I think that the difficulties in the condo market will not be solved by 25 or even 50 basis points,” he said. “The condo market is in the process of adjusting, clearing, and therefore I see some adjustment – including, possibly, price adjustment over the next six to eight months.
“The detached segment of the market, I think, is relatively OK. The inventories are not there, the demand is still there and the impact of low interest rates will be more significant there. [But] I still believe that the condo space will be relatively soft over the next six to eight months.”
Still, the move provided at least a modicum of relief for homeowners on variable rates, who have finally seen their borrowing costs tick lower after a rapid increase since the early months of 2022.
More good news could be ahead, Tal said – although he underlined the importance of keeping a close eye on developments in the US before jumping to conclusions about how quickly, and by how much, the Bank of Canada’s policy rate is likely to fall.
“I think [the cut is] very good news [for homeowners] – and I think that this is just the beginning of the downward trend,” he said. “The only thing that might stop the Bank of Canada, again, is the US. So we have to watch the US more than we watch Canada at this point.”
