To cut or hold interest rates — all eyes are on the Bank of Canada (2024)

This Wednesday’s rate-setting announcement will be closely watched for the obvious reason that some expect the Bank of Canada to cut rates for the first time since it began cranking them up in March 2022.

A less obvious reason is that a failure to cut or at least signal that a trim is coming very soon risks grinding the economy to a harmfully slow pace.

“It would be a mistake to maintain this degree of pressure on the economy now that inflation is decelerating sharply,” said Avery Shenfeld, chief economist at CIBC Capital Markets, adding that a cut to the current five per cent overnight rate would be “well justified” in June.

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“Standing pat for too long while inflation tumbles risks dishing out more economic pain than necessary to hit the two per cent (inflation) target,” he said.

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The Canadian economy grew at an annualized rate of 1.7 per cent in the first quarter, according to a Statistics Canada report Friday, which was below the Bank of Canada’s latest forecast of 2.8 per cent and economists’ estimates of 2.2 per cent. What’s more, the previous quarter’s growth was revised downward to 0.1 per cent from one per cent.

Still, not everyone is betting on a rate cut and market watchers expect some volatility regardless of whether there’s one or not.

James Orlando, a senior economist at Toronto-Dominion Bank, said Bank of Canada governor Tiff Macklem and his policymakers have prided themselves on transparency, but there hasn’t been a clear signal that the tide will turn on June 5, despite economic indicators signalling the time is right.

“We have been arguing for months now that inflation dynamics have been justifying rate cuts, yet the Bank of Canada hasn’t signalled any intention to make a move,” he said in a note on Friday.

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The divergence in expectations, with some corners of the market including overnight swaps strongly signalling a June cut, suggests a big market reaction to whatever is announced.

“It’s rare to have the market nearly split this close to a rate decision, so there will be a fair-sized market reaction either way,” said Douglas Porter, chief economist at Bank of Montreal. “Short-term bonds and money markets would show the biggest moves, followed by the currency and long bonds, followed by some reaction in interest-sensitive equities.”

Longer term, an interest rate cut would be more meaningful because it would mark an important shift in monetary policy, he said.

“It’s a big deal when policy starts heading officially in a different direction,” he said. “Even though the Bank (of Canada) willno doubt take things gradually on the way down, it is still a watershed, and a potential source of comfort to borrowers, knowing that at least some rate relief is on the way.”

Canada’s biggest banks, which reported mixed second-quarter financial results last week, are closely watching monetary policy to determine whether they are making the appropriate provisions for credit losses as businesses and households show the strain of a prolonged period of higher rates.

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Porter said the housing market could be a beneficiary of a June rate cut.

“The start of rate cuts could definitely brighten the mood in what’s been a mostly quiet spring market,” he said.

Andrew DiCapua, senior economist at the Canadian Chamber of Commerce, said the latest gross domestic product data isn’t expected to throw the Bank of Canada off course to make a shift in monetary policy.

“This is a good problem for the Bank of Canada to have,” he said. “With inflation moving sustainably towards the target, the (central) bank is running out of reasons to maintain restrictively high rates.”

The consumer price index (CPI) excluding shelter costs is at 1.2 per cent and only one-third of the CPI “basket” is growing above three per cent, so “inflation is on a clear path down to target and is no longer broad-based,” DiCapua said.

“While I wouldn’t be surprised if the bank’s data dependence delays this (first cut) until July, the choice is clear,” he said.

Shenfeld said the most important signal for the economy this week is a strong message from the central bank that a rate cut is coming, even if the cut itself doesn’t come for another month.

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“The difference to the economy from doing the first rate cut now, as opposed to in July, would be trivial six months from now, but what is important is that the Bank (of Canada) delivers a rate cut now, or at a minimum, gives a strong signal that it will do so soon,” he said.

“We needed a cooling-off period for the economy to get inflation under control, but it would be a mistake to continue to put the same degree of pressure on the economy.”

• Email: bshecter@nationalpost.com

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