Bank of Canada Preview: More Cuts on the Horizon
Charu Chanana
Chief Investment Strategist
Key points:
- The Bank of Canada is expected to cut rates by 25bps to 4.50% at the July meeting, following its initial rate cut in June.
- June inflation undershot projections and retail sales also declined. Labor market conditions have worsened, but persistent wage pressures may mean a more balanced statement remains likely.
- The rate differential between the BoC and the Fed is widening, potentially making the CAD more vulnerable. However, upcoming US political developments and market expectations of Federal Reserve actions could also impact the CAD’s performance.
The Bank of Canada (BoC) is expected to continue its path of normalizing rates with a possible 25bps cut to 4.50% at the upcoming July policy meeting after it kickstarted the rate cut cycle in June.
The BoC had emphasized a cautious, data-dependent approach following its June rate cut. With June inflation easing and unemployment rising, a second consecutive rate cut in July appears likely. Concurrently, the Federal Reserve seems closer to starting its own rate cut cycle amid broadening US economic data weakness. The BOC also has a historical tendency for consecutive moves at the start of a cycle, reinforcing the likelihood of another cut this month.
Economic Backdrop Offers Easing Excuse
- Inflation: The June inflation print undershot expectations to come in at 2.7% YoY vs. BOC’s 2.9% projection, supporting the case for further easing. Core inflation did not slow as anticipated but also did not increase compared to May, suggesting it may not significantly hinder additional cuts.
- Retail Sales: May retail sales fell by 0.8% MoM and the April print was also revised lower, indicating that consumer spending may drag on second-quarter GDP.
- Business Outlook: The Q2 Business Outlook Survey suggests firms expect continued easing of inflation pressures, with improvements in capacity constraints and labor shortages.
- Labor Market: Labor market conditions worsened in May and June, with total payroll growth in June declining by 1.4k and the unemployment rate rising to 6.4% from 6.2%. Persistent services inflation and stronger wage growth may receive closer scrutiny during the BoC’s deliberations.
Other Considerations
- Policy Divergence to the Fed: The BoC’s policy rate is already 75bps below the Fed funds rate, and another cut would widen this gap to 100bps, the largest since 2006. This could make the CAD vulnerable, though expectations of Federal Reserve easing in September may alleviate some of this concern.
- US Politics Could Strengthen USD: The increasing probability of a Trump 2.0 presidency and aggressive fiscal policies may drive demand for the US dollar, potentially pressuring CAD. However, markets are unwinding the Trump Trade to some extent with President Biden stepping away from the race.
Potential Impact on CAD
Overall, while there may be reasons for the BOC to cut rates again, the statement could turn slightly less dovish and more balanced to reflect the momentum in June core inflation and continued wage pressures. This could mean that a data-dependent approach is emphasized and the central bank could remain away from committing to further rate cuts.
- Short-Term: If the BoC delivers a rate cut accompanied by a balanced statement, the CAD may experience limited decline. The market is also pricing in a September Fed rate cut which could put the US dollar on the backfoot. However, a dovish statement with clear indications of further rate cuts could lead to a more pronounced decline in the CAD.
- Medium-Term: The Fed-BOC rate differential would continue to argue for a weaker CAD. However, US politics will gather increasing focus in the months ahead. If protectionism related to a potential Trump victory is priced in, the CAD might be less vulnerable compared to other high-beta currencies like the AUD, given the Canadian economy is likely less vulnerable to protectionist policies. Conversely, if Kamala Harris gains traction in polls, the CAD might underperform as focus turns back to rate differentials and rising hard landing risks in the Canadian economy.
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