Bank of Canada Decision: Is Another Rate Cut on the Horizon?

One of the most anticipated economic events of the week is the Bank of Canada's monetary policy meeting scheduled for tomorrow, Wednesday, 4 September. The central bank's decision on interest rates is likely to have an impact on market sentiment over the Canadian markets. 

Instruments like Canadian indices and all currency pairs that include the Canadian Dollar (CAD), such as the USD/CAD (USDCAD) and the EUR/CAD (EURCAD) could be influenced by this Canadian market event. Let’s take a closer look:

Is Canada's Economy Fading?

Canada's economy grew at an annualised rate of 2.1% in the second quarter of 2024, surpassing the 1.6% growth expected by markets and the 1.5% forecast by the Bank of Canada (BoC). 

The second quarter growth was primarily driven by increased government spending and wage adjustments, rather than broad-based economic strength. So despite this stronger-than-anticipated Gross Domestic Product (GDP), there are some sub-indicators that suggest that the Canadian economy may be losing steam.

One concerning sign is the continued decline in GDP per capita, which fell by 0.1% in the second quarter, marking the fifth consecutive quarterly decrease. Additionally, economic growth was flat in June, and preliminary estimates from Statistics Canada indicate no growth in July. 

In his July monetary policy announcement, BoC Governor Tiff Macklem hinted at a potential shift in the central bank's focus, suggesting a move towards supporting economic growth rather than solely targeting inflation. This shift in messaging has been interpreted by economists as a sign of growing concerns about the weakening economy.

Canada Faces Lower Inflation & High Unemployment

Canada's annual inflation rate, or Consumer Price Index (CPI), declined in July 2024, reaching a 40-month low of 2.5% and the slowest year-over-year increase since March 2021. 

This marks a significant step towards the Bank of Canada's target inflation rate of 2%, which could suggest that the Bank of Canada may have more flexibility in its monetary policy decisions.

​​Despite recent efforts to stimulate job growth, the Canadian labour market continues to exhibit signs of weakness. 

The unemployment rate held steady at 6.4% in July 2024, following increases in May and June. This represents the highest level since January 2022, when it reached 6.5%. Since January 2024, the unemployment rate has risen by 0.7 percentage points.

Additionally, the labour force participation rate declined to 65% in July, the lowest level since the pandemic year. 

This decline is primarily attributed to a segment of the population opting out of the labour force, including ageing baby boomers and younger individuals. While the first demographic category has been contributing to the downward pressure on participation rates for some time, younger people have been largely driving the decrease in July 2024.

What Can Traders Expect From the Bank of Canada?

After maintaining the interest rate at a 23-year high of 5.00% for approximately a year, the BoC voted for two consecutive 25 basis point reductions in June and July. The central bank is widely expected to lower the overnight rate for a third straight meeting in September.

A Reuters poll conducted from August 27-29 revealed that all 28 surveyed economists predict a further rate cut of 25 basis points, bringing the rate down to 4.25% on September 4th. 

Moreover, three of the five major Canadian banks—Royal Bank of Canada (RBC), Toronto-Dominion Bank (TD), Bank of Montreal (BMO), Canadian Imperial Bank of Commerce (CM), and Bank of Nova Scotia—are forecasting a total of five rate cuts in 2024. ING (INGA.AS) projects that interest rates will continue to decline, reaching 3% by the end of the second quarter of 2025.  (Source: Reuters)

Conclusion

As some economic indicators are pointing towards a slowing economy, burdened by high interest rates, it has increased speculation about a continuation of an upcoming rate cut from the BoC during tomorrow's policy meeting.

Rising unemployment, lower inflationary pressures and a significant number of mortgage renewals expected next year seem to also be adding pressure to the BoC to continue lowering its key rate.

​​While some analysts predict the Bank of Canada will implement further interest rate cuts in September and in the coming months (mostly in October and December), the ultimate trajectory of Canadian monetary policy remains uncertain. Only time will reveal the exact course of action the central bank will take.