Don't Fight The Fed; Round Deux.

 

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Well, our comment several weeks ago that “rates to fall, in fall” was somewhat correct. This week (still technically summer), we had both the Bank of Canada and US Federal Reserve lower their key overnight rate by 25bps. Both moves were priced into market expectations the days leading up the announcement following weaker-than-expected inflation data and a cooling labour market.

Starting on the home-front, the Bank of Canada cut its key overnight lending rate 25 bps to 2.50%, the first cut in six months. The explanation for the shift in the Bank's view since the prior meeting in July was straightforward, and is very much in-tune with our logic on today's decision. Specifically, three changes in the economic landscape were cited:

1) The labour market has softened further. Since the July meeting, Canada's economy has promptly shed 106,000 jobs, and the unemployment rate has climbed two ticks, while wage growth has eased.

2) Upward pressure on underlying inflation has diminished. This is perhaps the most important revelation in Wednesday’s discussion, with the BoC viewing the two latest CPI releases as less threatening. One example: the three-month annualized trend in median CPI has gone from 3.4% to 2.6% since the July meeting.

3) The removal of most retaliatory tariffs takes further heat off core CPI. This step was at the start of this month, so will begin to affect upcoming CPI results - economists estimate this could clip inflation by 0.1-to-0.2%.

More broadly, the Bank also noted that global growth seems to be softening more recently, pointing to signs of cooling in China and Europe. For Canada, the Bank saw the weak Q2 GDP result "as expected", and even played up the strength in household spending. The latter could cool, given slowing population growth and a weaker job market.

Looking ahead, the Bank continues to highlight risks and uncertainties, noting they intend to "look over a shorter horizon than usual" and proceed "carefully". The evolution of trade/tariffs and how that impacts the economy, inflation and inflation expectations are keys. Notably, the Statement does not mention the potential for further easing (unlike in July), suggesting they're not keen to provide a follow-up cut in October. Still, policy will evolve with the data, and further economic weakness and slowing inflation will likely eventually prompt further cuts.

Bottom Line: The rate cut better balances the risks to the economy and inflation. The BoC left its options wide open on the next meeting, maintaining a focus on a shorter-term horizon than usual to determine the path for policy. For now, BMO’s economics team is sticking to their call that the Bank will cut two more times in coming months, although moving every other meeting (i.e., cuts in December and next March).

Looking to the US Fed, the FOMC cut policy rates by 25 bps, with the fed funds target range at 4.00%-to-4.25%. This restarts the rate cut campaign which had been on hold since December (after a total of 100 bps in the final four months of last year). The Fed was waiting to see how the Administration’s economic policies unfolded (particularly on tariffs) along with their economic impacts (particularly on inflation). Until recently, solid labour market conditions, acknowledged as recently as July 30, afforded the Fed time to wait. But since then, the labour data have weakened significantly. The reference to “solid” was removed.

The press release said, “job gains have slowed, and the unemployment rate has edged up” but also stated that “inflation has moved up and remains somewhat elevated”. However, while still “attentive to the risks to both sides of its dual mandate”, the Committee “judges that downside risks to employment have risen” and were no longer balanced (which was the case last meeting). Indeed, the weaker labour market conditions (on the ground) along with the “shift in the balance of risks” were the catalysts for the resumption of rate reductions.

And more rate cuts appear to be coming. In their forecast of future rates, aka the ‘dot plot’, the median forecast for the fed funds rate has a further 50 bps worth of easing this year (25 bps more than the past meeting), and 25 bps next year (same as before but ending, of course, a quarter-point lower).

It’s noteworthy that among the other economic projections (and compared to three months ago) the median forecast profile for real GDP growth was boosted a bit (by 0.1 to 0.2% through 2025-2027) and the unemployment rate was lowered a little (by 0.1 %in 2026-2027). Meanwhile, the forecast for total and core inflation was lifted by 0.2% for next year. All other figures were the same as before. We reckon the slight upgrade to both growth and inflation will be one factor keeping the resumption of rate cuts on a tentative track.

Bottom Line: With policy rates still 100-to-125 bps above the neutral level and the deterioration in labour market conditions expected to persist through at least the turn of the year, we reckon the ‘dot plot’ is a decent road map for the remainder of this year. BMO’s economics team now looks for two more quarter point rate cuts this year (October-end and mid-December), compared to only one more action previously.

 

Sources: BMO Economics BoC Rate Decision — Back to the Chopping Board, BMO Economics FOMC Policy Announcement & SEP — Rate Cuts Restart

 

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