When a central bank makes a more aggressive decision on where to set rates, the risk is that the market will read something else into the move and assume the bank knows something investors don’t. Today, the Bank of Canada took out its long iron and cut the overnight rate target by half a percent to 3.75%, which is the lowest it has been since December 2022. This was not a move to play catch up with half-point cut by the Federal Reserve at its last meeting, but a reaction to two key facts. Canada’s economy has stumbled and is operating below its capacity and inflation has dropped to below the Bank’s 2% target.

Since the Bank started to rein back on the degree of restrictiveness in policy at the start of the summer, it has now lowered rates 1.25%. In both the policy statement and Governor Tiff Macklem’s press conference, the message is clear that it will continue its agenda of lowering rates as long as the data supports such moves. The question is whether these moves will match what we saw today or return to a steady pace of quarter-percent cuts seen in the summer? 

As I commented on BNN Bloomberg’s The Open this morning, there is really no need for the Bank to repeat today’s decision at the next meeting in December or in Q1. While the neutral interest rate (or R*) is a moving estimate, most economists agree that it is probably in the 2.5-3.0% range for Canada. To get there, the Bank only has to nudge rates down the same amount as what it delivered in the three meetings prior to today. If so, that would take us to neutral territory by the end of Q1. You could also allow for a few pauses along this trajectory and still reach neutral by this time next year.

There are also risks to applying the same pressure to the gas pedal. Even though the consensus on the street was for a larger move by the Bank today, the Canadian dollar still came under pressure and edged even closer to 72 US cents. This level has held since the end of 2022, but a break below could easily send the currency down through 70 cents. The combination of a weaker Loonie and resilient economic activity in the US could translate into higher inflation here. On top of that, we don’t know whether fiscal policy in the US is about to become more stimulative and if increased deficit spending also results in higher inflation.

For now, Canadians with excessive debt will find relief in today’s decision.  As the chart above shows, bond yields did not respond positively to the Bank’s move as a larger rate cut had already been baked in. For that reason, we could see momentum in financials and interest-sensitive stocks fade. We still think that bond yields will continue to fall (bond prices improving), but the pace is likely to be slower than what have just seen.

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

Andrew Pyle