Bank of Canada October Meeting: Another Rate Cut, but with a Cautious Outlook

The Bank of Canada reduced its overnight lending rate by 50 basis points today, bringing it down to 3.75%. This was widely anticipated, marking the fourth consecutive cut and totaling 125 basis points in reductions. Notably, this is the most aggressive set of rate cuts among the major central banks globally, with no other G10 bank going beyond 75 basis points—the Fed has only cut 50 basis points, while the Reserve Bank of Australia hasn't started cutting rates yet.

This move represents the largest rate cut since the COVID-19 pandemic. The Bank’s intention is to support economic growth and stabilize inflation, which has dipped below its 2% target. Governor Tiff Macklem emphasized that future rate adjustments would be data-dependent, suggesting that further reductions will only occur if economic indicators support such action.

The Bank’s tone in its accompanying statements and Monetary Policy Report (MPR) was dovish, as expected given the magnitude of today’s move. However, the underlying message suggests that the Bank is now likely to take a more cautious approach, focusing heavily on incoming data before deciding on further action. It appears that the Bank is in no rush for another large move and will take a measured stance going forward.

Key Highlights from the Bank’s Statements:

• "The Bank expects inflation to remain close to the target over the projection horizon, with the upward and downward pressures on inflation roughly balancing out." This indicates a shift, as the Bank no longer expresses particular concern about guarding against downside risks.
• "There are risks around our inflation outlook. The biggest downside risk to inflation is that it could take longer than anticipated for household spending and business investment to pick up. Our recent surveys suggest businesses expect subdued sales and their hiring and investment plans are modest. On the upside, lower interest rates could fuel a stronger rebound in housing activity or wage growth could remain high relative to productivity. There is also elevated geopolitical uncertainty and the risk of new shocks." The Bank remains confident that past rate cuts will support growth and mitigate downside risks for inflation. However, they acknowledge the possibility of a slower recovery and emphasize concerns about still-elevated wages and a potential rebound in housing activity.
• "If the economy evolves broadly in line with our latest forecast, we expect to reduce the policy rate further. However, the timing and pace of further reductions in the policy rate will be guided by incoming information and our assessment of its implications for the inflation outlook. We will take decisions one meeting at a time." This suggests that the Bank will likely proceed with smaller, 25 basis point cuts in future meetings, unless economic data presents a more significant downside risk.

Economic Forecasts:

The Bank’s latest quarterly forecasts show minimal changes since July. Despite a significant miss in Q3 GDP growth (1.5% versus the expected 2.8%), the full-year estimates for 2024 and 2025 remain unchanged due to strength in surrounding quarters. The Bank made a minor adjustment to its 2026 forecast, trimming it by a tick, but this is not expected to significantly impact their policy approach in the near term. Similarly, the Bank's outlook on headline inflation has been slightly reduced, but the two-year core inflation projection remains stable.

Bottom Line:

Today's significant rate cut primarily responds to the recent decline in headline inflation. However, the Bank's broader outlook and cautious tone suggest that future rate adjustments will likely come in smaller increments of 25 basis points unless further downside risks materialize. While we cannot entirely rule out another 50 basis point cut, our forecast aligns with a gradual path of smaller cuts, expecting the overnight rate to reach 2.5% by mid-2025. This remains at the lower end of the Bank's neutral range of 2.25%-to-3.25%.