Markets had just about fully priced in today’s 50 basis point rate cut by the Bank of Canada. What they weren’t so much expecting was the bank’s hawkish turn when it comes to future guidance.
The bank said it will now take a “more gradual” approach to further easing. In its rate decision statement, it also removed an earlier reference to expecting further rate cuts.
The reaction was immediate.
The Canadian dollar and bond yields spiked on the 945 am announcement and related Bank of Canada commentary. The loonie rose by about a quarter of a US cent to 70.75 cents US. The Canadian dollar prior to the announcement was trading at its weakest levels since the start of the Covid-19 crisis in April 2020, and was down roughly 6 per cent so far this year.
The Canadian two-year bond yield, which had been lower prior to the decision and is particularly sensitive to central bank policy, rose to 2.91 per cent from 2.85 per cent.
Going forward, money markets are now assuming we’ve reached the end of jumbo-sized 50 basis point rate cuts and future cuts will be 25 basis points - if at all. And over the course of next year, they are only pricing in between 50 and 75 basis points of additional rate cuts.
Implied interest rate probabilities in overnight swaps markets now suggest a 67 per cent chance of a 25 basis point cut at the next policy meeting on Jan. 29, and 33 per cent odds that there will be no change at all to the bank’s overnight rate.
Here’s how implied probabilities of future interest rate moves stood in swaps markets at 1008 am ET Wednesday, according to LSEG data. The overnight rate now resides at 3.25 per cent. While the bank moves in quarter-point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.
The second table to the bottom is a breakdown of probabilities for the size of a cut on Jan 29.
Here’s how economists and market strategists are reacting in written commentaries:
David Rosenberg, president and founder of Rosenberg Research
The Bank of Canada 100% did the right thing today by cutting its policy rate -50 basis points once again to 3.25%, as the market had been anticipating. At the same time, it did remove the forward guidance that more relief is necessarily going to be coming our way after the -175 basis point slice off the cycle peak since June (more cuts will hinge on economic activity and inflation coming in below current expectations). While some may label this a “hawkish cut” (a bit of a stretch — though the loonie seems to think the BoC may pause as it has rallied in the aftermath of the move), we are still leaning towards more cuts ahead — all the more so if Donald Trump follows through on his tariff threat.
At the margin, the BoC is still leaning towards additional easing, stating that “[…] we will be evaluating the need for further reductions in the policy rate one decision at a time.” That is a message that markets should not be front-running the next policy meeting, but what is more important is the final destination, not the path itself. Governor Macklem snuck into this press conference a remark that, “[…] we anticipate a more gradual approach to monetary policy if the economy evolves broadly as expected.” That means that the Bank may be finished with jumbo cuts and moving every meeting, but it will still be moving (i.e. rates are going lower). And then there was this little ditty: “But the economy remains in excess supply and the growth outlook now appears softer than we projected in October.” That’s a crucial message that means interest rates and bond yields will still be moving fundamentally in one direction: Down.
The policy rate is now at the high end of the Bank’s estimated range of “neutral,” but with the economy operating under a chronic state of excess supply and the admission that the disinflationary output gap will likely not close for at least another year or two, the final destination is probably going be close to 2% (possibly even lower). Take note that in each of the five rate-cutting cycles, the trough was no higher than 2%, so it’s not a bad idea to make that a base-case forecast. Patterns matter. That means another -50 basis points of potential additional yield decline in the 10-year GoC bond (now at 3.07%), so good news for fixed-income (less so for the Canadian dollar) — not to mention Bank stocks and the array of dividend-oriented sectors that feed off of lower interest rates, from Utilities to Pipelines to REITs to Telecom services.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
The decision to cut rates another 50 basis points today reflects the Bank of Canada’s desire to get to the same destination via a slightly different route than we had anticipated. Our view was based on the central bank’s stated risk management approach to policy, which strives to avoid policy errors. A slower pace of reduction would have afforded a bit more time to assess the economy’s response to lower rates. That said, the forward guidance accompanying today’s rate decision suggests that the monetary policy reaction function being employed is largely as we had expected. After cutting rates another 50 basis points, officials sent a strong signal that further cuts of that magnitude should not be expected. Moreover, policymakers seemed to hint at an upcoming pause in the cutting cycle.
Our interest rate outlook is, therefore, little changed. Instead of cutting rates 25 basis points at each of its first three decision dates of 2025, we now see the Bank of Canada briefly pausing in March after beginning the year at a lower level. That leaves our mid-2025 and end of year projections intact at 2.75% and 2.25%, respectively. That reflects our longstanding view that rates need to fall further to cushion the blow from upcoming mortgage renewals and slower population growth. We are also retaining our call for a terminal rate of 2.00% to be reached in 2026, in light of our forecast that Canada will face at least some tariffs on exports headed to the US.
Avery Shenfeld, chief economist with CIBC Economics
The Bank is probably happy that this wasn’t a rate decision that comes with an updated economic forecast. We’re in the same boat as the central bank at this point, waiting for developments on two fronts that could impact both growth and monetary policy ahead, in two opposing directions. While the fiscal measures announced to date will have only temporary impacts, which the Bank will look through, there are rumours of more substantial federal measures being considered for the upcoming Fall Economic Statement. If these entail a timely, material, and lasting boost to economic activity, that could lean against the need for aggressive rate cuts ahead. But on the other side, there’s a looming threat of US tariffs. That uncertainty will weigh on business investment even if the tariffs never arrive, but could entail a major hit to exports if actually delivered, and therefore require more monetary stimulus to Canadian domestic demand. Who can blame the Bank of Canada for dropping forward guidance and leaving forecast details until January? That said, barring material fiscal stimulus, the fact that the economy is growing below potential, with an accelerating climb in unemployment, suggests that we’ll need to take rates somewhat below neutral to achieve the Bank’s objectives for a growth improvement. Our estimate of the neutral rate sits at 2.75%, the midpoint of the Bank’s estimated range, and we see the overnight rate getting to 2.25% on a series of quarter point cuts ahead.
Douglas Porter, chief economist with BMO Capital Markets
In the short space of six months, the Bank has driven the overnight rate from a highly restrictive 5% level right down to the top end of their estimate of neutral rates at 3.25%. Now, the BoC has directly signalled that the pace of cuts will slow, perhaps dramatically—the Bank even noted that it will now “evaluate the need for further reductions”. Ultimately, given the slack in the economy, and the cloud over the trade outlook, we look for some further small rate trims of the 25 bp variety in 2025, bringing the overnight rate down to 2.50% before mid-year (i.e., at the lower end of neutral). As the Bank notes, the major wildcard is what unfolds on the tariff front, and how Canada responds; suffice it to say, rates are going lower still if broad U.S. tariffs are imposed on Canada.
Tiffany Wilding, economist at PIMCO
The policy rate is now at the top end of the BoC’s 2.25-3.25% neutral range, meaning monetary policy is no longer ‘clearly restrictive’. The growth outlook appears set to underperform the BoC’s forecast from October, with the Governor pointing to likely downward revisions as the latest Government immigration targets signal a sharp slowdown in population growth. Although recent fiscal announcements suggest temporary support to consumption, while exports may be accelerated ahead of any potential tariffs, the Bank of Canada is likely to look through these and focus on a more medium-term outlook for growth.
Communications were on the hawkish side, but we continue to expect the policy rate to further decline at a 25 bps pace until it is in the lower half of the neutral range as the Bank of Canada seeks to stabilize an economy in excess supply and arrest the upward trend in the unemployment rate. Although the threat of tariff remains a major uncertainty to the Bank of Canada and not their base assumption, any implementation is likely to push the Canadian economy into an even weaker state and necessitate additional cuts from the Bank of Canada.
Claire Fan, economist with Royal Bank of Canada
In Q3 there were already tentative signs that economic activities, especially those that are interest-rate sensitive (consumer spending, housing) are picking up. Still, business spending was softer and there is still slack in the economy. Interest rate cuts will continue to work to stimulate activities, especially labour market, with a significant lag.
We expect per-person GDP to remain soft in the near-term, and unemployment rate will keep edging higher before leveling out at round 7% early in 2025. Persistent softening in the economy into 2025 should ultimately motivate the Bank of Canada to cut rates down to stimulative territory, at 2%.
James Orlando, director and senior economist, TD Economics
The recent rise in the unemployment rate alongside weaker-than-expected GDP was enough to convince the BoC that another supersized rate cut was warranted. We think this misses the forest for the trees. The rise in the unemployment rate is missing the fact that hiring has reaccelerated over the last few months, while underlying growth momentum has been robust with consumer spending driving fundamental demand. Not to mention, the real estate market has caught fire once again.
We don’t think the BoC will keep cutting at this current pace. The policy rate is in the bank’s ‘neutral’ range (2.25% to 3.25%), which means it probably thinks its rate is no longer weighing on economic growth. The central bank will also be getting more evidence over the coming months that economic growth is stabilizing around trend. Stronger growth will validate that it can cut at a slower pace. If it doesn’t, policy rate differentials with the U.S. will widen even more. And with tariffs potentially coming on Jan. 20th, the combination would likely push the loonie into the mid-60 U.S. cent range.
Taylor Schleich and Warren Lovely, economists with National Bank
The decision to cut 50 basis points wasn’t as clear cut as it was in October but the desire to reach a more neutral policy stance, softer GDP growth and a weaker labour market overwhelmed an upside inflation surprise and sticky wage growth. Having now entered the ‘neutral zone’ (estimated by the BoC to be 2.25% to 3.25%), there’s an apparent desire to dial back the pace of easing which markets interpreted hawkishly (2-year GoC yields underperformed U.S. treasuries by ~8 bps). Presumably, this reaction was supported by the absence of an explicit rate cut pledge and an emphasis on graduality. However, we simply view this shift in language as an appropriate adjustment to a now much less restrictive policy stance. Indeed, our base case never incorporated continued 50 basis point cuts beyond this point. We certainly don’t interpret it to mean that a pause is imminent or that rate cuts will cease. If the economy evolves as we expect (i.e., more sluggishness), we don’t think the Bank will hesitate to cut further. Rather, they’re now just likely to make more standard-sized adjustments from here (i.e., 25 bps). And keep in mind, the Bank’s outlook for the economy has been among the most optimistic out there. Perhaps the bar for disappointment (and thus further cuts) isn’t all that high. In addition, more vague rate guidance is consistent with growing uncertainty on the horizon (most notably, on trade, fiscal and immigration policy). At this point, we’re still looking for the Bank to cut 25 basis points in January, subject to incoming data and developments in Ottawa and Washington.
Stephen Brown, deputy chief North America economist, Capital Economics
Although the Bank of Canada cut interest rates by another 50bp today, its communications were more hawkish than might have been expected, with the Bank no longer indicating that further cuts are guaranteed and instead saying it “will be evaluating the need for further reductions in the policy rate one decision at a time.” We still anticipate three more 25 bp cuts, but there are risks in both directions.
David Doyle, head of economics at Macquarie
Governor Macklem’s tone was balanced during the press conference, but did suggest that further rate cuts will be considered. He outlined that there would be a “more gradual” approach to policy ahead. We believe with unemployment elevated and inflation likely to continue to moderate, policy will need to turn accommodative. Our outlook remains for further cuts ahead. In 1H25, we expect four successive cuts of 25 bps, with the overnight rate reaching 2.25% in June. Risks to this lie towards sharper and more aggressive easing, particularly should tariff threats against Canada come to fruition.
Charles St-Arnaud, chief economist, Alberta Central credit union
Overall, the BoC continues to signal that the policy rate will likely continue to decline the coming months. However, the likelihood of another 50bp is now very low. We continue to expect that the BoC will remain on an easing path and we expect the central bank to cut again at the Janaury meeting.
However, with the policy rate close to neutral, the focus should turn to the terminal rate in the easing cycle. With the sharp deceleration in population growth next year and its impact on growth, we believe that the terminal rate may be close to 2.0% still higher than than pre-pandemic.
Derek Holt, vice-president and head of Capital Markets Economics, Scotiabank
The Bank of Canada met almost everyone’s expectations including ours and cut 50bps today. I wasn’t a fan of them doing so despite forecasting the outcome but like the more careful bias which is what drove the market impact. This was, in short, one of the most hawkish upsized cuts in the history of upsized rate cuts across global central banks. It almost had the feel of having an apology note attached to the decision. That’s because the market outcomes left traders with a lump of coal in their stockings care of the BoC. Dovish market bets on the Bank of Canada got crushed despite delivering the 50bps cut that itself was largely priced going in. ... The reason for this rates market reaction is because the BoC called time out on forward guidance. They signalled greater uncertainty over future rate cuts than in the prior statement.
Tu Nguyen, economist with national accounting and consultancy firm RSM Canada
Since inflation has already been around 2% for some time, easing interest rates from restrictive territory seems overdue.
The challenge for the Bank moving forward is to manage interest rate given the widening growth and interest rate differentials between Canada and the US. The Bank of Canada’s interest rate currently stands 150 basis points below the Federal Reserve’s, a gap that not seen for over a decade.
We expect more rate cuts in early 2025 to get the economy onto an expansionary trajectory, to bring to policy rate down to 2.75% within the first half of the year.
Nick Rees, senior FX market analyst, Monex Canada
Regardless of today’s decision, we still think our core thesis for the Canadian economy remains intact. Namely, that the end of 2024 will bring a false dawn for growth, one that should be crushed by Trump tariffs in 2025. As such, we are inclined to take the Bank’s suggestion that it “will be evaluating the need for further reductions in the policy rate one decision at a time” with a degree of caution. If our base case for tariffs holds, and Trump does impose a 25% levy on Canadian imports early next year, then a significant additional quantum of policy easing will be warranted, widening rate differentials between the US and Canada.
This point was addressed in both the statement and the press conference. The former noted a “possibility the incoming US administration will impose new tariffs on Canadian exports to the United States has increased uncertainty and clouded the economic outlook”. Macklem took a similar tone in his press conference too – recognising the risks posed by tariffs, but avoiding committing to a view on the potential impacts ahead of implementation.
In our view, and in light of the BoC’s latest statements, we now anticipate a string of 25bp rate cuts moving forward. Set against what we expect to be a hawkish turn from the Fed next year, this should ensure a continued widening in rate differentials that support further USDCAD upside. As such, while the pair has dropped on today’s policy decision, we think this weakness is likely to be temporary. We still expect to see sustained USDCAD upside post-inauguration day.
Philip Petursson, chief investment strategist, IG Wealth Management
Our takeaway from the statement was that this has become a central bank on the back foot. ... While it isn’t our base case, the Bank has not closed the door on further 50 bps cuts in the future. With that said, the Bank is only 75 bps away from what we believe is the neutral rate of 2.50%. We believe further cuts from here will be 25 bps each such that by April we will have reached our target. But let’s not lose sight of the more important message– there are headwinds facing the Canadian economy from many fronts. A lower rate environment will help, but we need to keep in mind that changes to the policy rate take time to work their way through the economy. The first half of 2025 will likely continue along a slower path for the Canadian economy until the first of the rate cuts earlier this year start to make an impact. The Bank of Canada will continue with continuous cuts to its overnight rate. They are off to a good start in normalizing rates and returning the Canadian economy to growth, but it will take time.
Ashish Dewan, investment strategist at Vanguard Canada
BoC has shifted its focus towards growth, and we expect continued policy easing with a 2025 year-end-policy-rate near the low end of the BoC’s estimate for neutral rate of 2.25% to 3.25%. This decision was driven in part by a recent interest rate cut by the US Federal reserve, a jump in Canada’s unemployment rate to multi-year highs, along with a decline in real GDP per capital for the sixth consecutive quarter.