While most economists expected the Bank of Canada to cut rates for a second consecutive time today, investors wondered whether officials might be concerned about the implications of lowering rates when U.S. rates held steady, with respect to the currency and inflation. That apparently is not the case and this morning we got a second straight quarter-point reduction in the Bank’s overnight target, taking it to 4.5%.

 

 

The key drivers behind today’s decision include the continued retreat in headline inflation, which fell to 2.7% in June and while core inflation did show a surprising uptick. The accompanying statement again made note of signs of slack in the labour market and moderating wage growth. In addition, the Bank sees potential output growth exceeding the actual growth of the economy, implying that excess supply is increasing. This supports the Bank’s forecast that core inflation measures will decline to around 2.5% in the second half of the year and move towards its 2% target in 2025. The Bank is, however, still mindful of the elevation in shelter costs and other services prices and repeated that it will continue to monitory the effects of these areas on overall inflation.

 

That said, it is clear that the Bank’s assessment of risk has shifted more towards weakness in the economy and away from inflation.  It’s recent Business Outlook Survey, released last week, pointed to weak demand having a negative impact on investment and hiring plans and that most companies saw wage growth and inflation moderating. In the Survey of Consumer Expectations, it found that most consumers reported lower spending and pessimism over their future financial conditions. With three more meetings this year, we would anticipate at least one more move on rates and possibly two.

 

 

Of course, the Bank does not comment on the Canadian dollar nor comparisons between how it’s policy stance and that of other central banks. Market participants, however, have focused in on the fact that today’s cut takes the spread between the Bank’s overnight target and the Fed funds rate to minus 1%, which is the widest it has been since 2007, as the above chart shows. The next FOMC meeting is next week, though few economists expect the Fed to lower rates.

 

As I mentioned in yesterday’s conference call, we may likely see another cut in September and if the guidance next week supports that, it is possible that the downward pressure on the Canadian dollar will be limited. We did see the Loonie sell off modestly this morning and it is getting close to its weakest levels it slipped to in April, near 72.30 U.S. cents.  If this level fails in the weeks leading up to the September FOMC meeting, then it would be a break of 72 cents in play. At that point, economists and possibly Bank officials might become more concerned that this could fuel inflation, via higher import prices.

 

There are three policy meetings remaining this year and our view remains that we will see at least one more quarter-point cut out of them.

 

On behalf of the Pyle Wealth Advisory team, have a great rest of the week.

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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