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Markets have reacted to the latest Bank of Canada interest rate decision and outlook by increasing bets that the central bank will start cutting interest rates in the second half of next year.

The Bank of Canada held its key overnight rate at 5.0% as expected and forecast weaker growth, even as it left the door open to more rate hikes to tame inflation that could stay above target for another two years.

Overall, markets took it as a dovish outlook. The Canadian dollar immediately weakened by about two-tenths of a U.S. cent, to 72.42 cents US, a seven-month low. But it soon retraced much of those losses, and was going for 72.52 cents by noon. The two-year Canada bond yield, which is sensitive to changes in central bank policy, moved lower, but was still higher on the day. At noon, it was up 6 basis points, after earlier being up by 10 basis points under the influence of rising U.S. Treasury yields.

Meanwhile, implied interest rate probabilities in swaps markets have now priced in greater than 50% odds that the Bank of Canada will start cutting interest rates by the end of next year. However, at the same time, markets are placing 41% odds on the tightening cycle not yet being over.

The following table details how money markets are pricing in further moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 1015 am ET. The current Bank of Canada overnight rate is 5%. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves.

Meeting DateExpected Target RateCutNo ChangeHike

And here’s how the swaps pricing looked just prior to the BoC decision:

Meeting DateExpected Target RateCutNo ChangeHike

Here’s how economists and market strategists are reacting:

Stephen Brown, deputy chief North America economist, Capital Economics

Although the Bank of Canada maintained its tightening bias today, the rest of the policy statement suggests that the Bank is growing more confident that its job is done. We continue to expect the Bank to cut interest rates by much more than markets are pricing in next year.

Admittedly, alongside its decision to leave the policy rate at 5.0%, the Bank stressed that it still thinks headline inflation will remain above the 2% target until late 2025. While the Bank upgraded its oil price forecasts as expected, there was little downward revision to its forecasts for core inflation despite the accompanying downgrade to its GDP forecasts. The Bank now forecasts GDP growth of 1.2% this year and 0.9% next year, down from 1.8% and 1.2% previously. Moreover, as the Bank believes that “supply and demand in the economy are now approaching balance,” those weaker forecasts imply that output will move further below potential in 2024 than previously projected. The new Monetary Policy Report does now show a downward impact on inflation from below-potential GDP growth from 2024 onward, but that has been offset by a large upgrade to the forecasted upward impact on inflation from the catch-all “other factors” category. In other words, the Bank seems to be fudging the results of its model – or more diplomatically erring on the side of caution – so that weak GDP growth does not feed through to lower inflation as quickly as would normally be the case.

That assumption will seem increasingly untenable if, as we expect, the surprise fall in core CPI inflation in September is a sign of things to come. Despite using the same oil price assumptions as the Bank for the next year, we see scope for headline inflation to return to the 2% target in the third quarter of 2024, a full year before the Bank anticipates. That is partly because, in contrast to the Bank’s view that the economy will avoid recession, we judge that we are already in the opening stages of one. We see scope for the Bank to begin cutting interest rates from around April 2024, taking the policy rate back to 3.0% by the end of the year.

Avery Shenfeld, managing director and chief economist of CIBC Capital Markets

The medicine we have to take to get inflation under control has some painful side effects, so it’s important to get the dosage right. Dr. Macklem is trying to do just that in his role as Bank of Canada Governor, and today’s decision to leave interest rates on hold reflects the fact that Canada’s economy is already seeing some of those side effects, rather than a judgement that our inflation maladies have been cured. While the Bank is clearly unhappy with the very limited progress seen of late on core inflation measures, and has raised it’s near term forecast for inflation somewhat, its willing to let the medicine we’ve already taken work its way through a sluggish economy into a deceleration in price pressures. But it still has retained its warning that higher interest rates would be in the offing if the inflation data persist in disappointing their projections. ...

The disappointments in second and third quarter growth necessitated a downward revision to 2023 GDP projection (to 1.2% from 1.8% previously) but the lack of momentum also shifted the 2024 forecast into a lower gear (to 0.9% from 1.2%). These aren’t yet painting a picture of an outright recession, but are slow enough to continue to open up economic slack and drive the unemployment rate somewhat higher. On the inflation front, a higher assumption for energy prices and the stickiness of core inflation bumped up the near term CPI outlook, which decelerates to 2.5% by Q4 of 2024 (versus 2.2% previously), but then gets to the prior target of 2.1% by the end of 2025. The text of the MPR is a bit more balanced on the inflation story rather than uniformly hawkish, as was more the case when they were hiking. ... The Bank is concerned about “corporate pricing behaviour”, but from our perspective, a cooling in labour income growth and the squeeze on spending power from higher mortgage rates will, over time, see companies that try to push through larger or more frequent price increases finding their sales drying up enough to force a return to more modest price hikes. There’s nothing like a pile-up of inventories to prompt a flurry on “on sale” stickers. That’s still, however, a forecast. In the here and now, with core inflation well above 2%, the Bank is still months away from dropping its warning that rates could have to climb again, let alone even whisper about an eventual easing. The warning could disappear if we get another significant leg down in core inflation, while any mention of rate cuts would have to be in the context of labour markets no longer looking tight and a path to 2% inflation being self-evident. ... We’ll stick to our view that the Bank of Canada has already delivered enough rate hikes to keep growth under wraps, and bring inflation down on a somewhat faster trajectory than its latest forecasts. That good news on the inflation front, and not so good news for growth, should be sufficient to bring a policy ease towards mid-2024, with overnight rates getting to 3.5% by the end of that year. While that seems a long way from where we are now, its still twice the peak interest rate of the prior cycle, and above the level that the Bank of Canada judges as neutral for economic growth.

Taylor Schleich, Warren Lovely & Jocelyn Paquet, economists with National Bank Financial

In the battle between slower growth and stickier inflation, the former won out at this meeting as the Bank opted for the cautious/prudent approach leaving rates unchanged. There is clearly some optimism from the Governing Council that rate hikes are working as the economy rebalancing gives them hope more meaningful inflation relief is on the horizon. Still, current inflation readings (core and headline) are keeping policymakers up at night as they’ve retained an unambiguous hiking bias, repeating the explicit threat from September to tighten further if needed.

Thinking about the near-term rate outlook, the evolution of recent data (i.e., conflicting signals of weaker growth and stronger inflation) presents a major challenge for Governing Council. For now, the weaker outlook trumps stickier inflation but at the end of the day, this is a single mandate* inflation-targeting central bank. With headline inflation printing above 2% for 31 consecutive months and counting, there is presumably limited tolerance for more upside inflation surprises. Fortunately, in the lead-up to today’s decision, September CPI data came in much softer than expectations which helped provide the cover to hold today. But if September’s relief were to prove temporary, the Bank may be forced to tighten further, even with the rapidly deteriorating demand backdrop. To be clear, our baseline growth and inflation forecasts are not consistent with further tightening but the volatile and unpredictable nature of the inflation trajectory over recent years warrants humility when it comes to assessing the path for price pressures. OIS markets should then continue to discount some odds (though less than 50%) of additional hikes. As for eventual rate cuts, you won’t see any mention of it today. Macklem will push back on this discussion in the imminent presser if/when asked and the revised inflation outlook suggests the scope for this is some ways off. Despite the understandable reluctance to discuss lowering rates, we do see scope for the start of a modest easing process to begin around the middle of next year. That’s earlier than market expectations, which have been volatile, are currently implying.

Derek Holt, vice-president and head of Capital Markets Economics, Scotiabank

The Bank of Canada delivered a hawkish hold as expected, but it was slightly more hawkish than I had expected going into it. The overnight rate was left at 5% as universally anticipated and so was ongoing quantitative tightening, while the verbiage retained a tightening bias that was anticipated. ...

I like the overall blend of communications that the BoC delivered here today. They struck a reasonable balance in their assessments while leaning cautiously against prematurely declaring victory over inflation while avoiding a promise to end rate hikes. ...

James Orlando, director and senior economist, TD Economics

The BoC didn’t throw any curveballs today. It acknowledged the growing evidence that economic momentum is slowing – falling retail sales, declining job vacancies, and a cooling housing market to name a few. All of this showed up in its updated forecast, where the BoC expects below-trend growth over the next twelve months. At the same time, the BoC didn’t declare victory. With wage growth running at 5% y/y and underlying inflation averaging 3.5% on a three-month annualized basis, the Bank is still leaving the door open to further hikes should economic data start to re-accelerate.

Although the BoC has painted a clear picture for why it doesn’t need to hike again, we expect its hawkish rhetoric to persist. It needs to maintain current tight financial conditions in order to achieve its forecasted slowdown. And while markets are hesitant to build in another hike, the impact of the BoC’s rhetoric has resulted in a higher for longer path for the BoC’s policy rate. This has the Canada 10-year yield sitting at its highest level since 2007.

Jules Boudreau, senior economist at Mackenzie Investments

The press release accompanying the Bank of Canada’s decision to hold rates at 5% is a depressing one. It paints a picture of a Canadian economy on the brink of stagflation. The economy is clearly slowing after growth picked up in the first half of 2023. But inflation is still well above target, and the Bank expects it to only drift back to 2% in 2025. The next few meetings will probably be uneventful: growth will be too soft to support hikes, but inflation too high to justify cuts. The Bank will be forced to walk on the 5% tightrope for a few quarters. But it won’t want to repeat its error from January, when it suggested that rates had reached their peak, before resuming hikes in June. The Bank’s credibility took a hit. So don’t expect any forward guidance in coming meetings: Tiff Macklem will repeat “we’re keeping rates unchanged, see you at the next meeting”.

We see inflation easing back below the 3% upper bound of its tolerance band in mid-2024, earlier than the Bank’s projections. If Canadian growth is as soft as the Bank is predicting in its revised forecasts, it’s difficult to see inflation staying so high for so long, absent fresh — and unpredictable — supply shocks. Inflation was much too high over the past year because the Canadian economy was overheating. As it cools, inflation should finally ease. Mortgage costs are currently the largest contributor to Canadian inflation. But mortgage costs should be seen as “price increases”, rather than inflation. As soon as rate hikes end, those price increases will begin easing, turning into a disinflationary force in a couple quarters.

Douglas Porter, chief economist, BMO Capital Markets

We have long believed that 5% rates are plenty high enough to eventually quell underlying inflation, but it will take time and patience. Strong wage growth and firm core inflation trends are going to test the Bank’s patience. However, all signs suggest that the economy is struggling mightily to grow—despite the artificial sweetener of a surging population—with Q3 GDP about flat, housing halting, consumer confidence crumbling, and the Business Outlook Survey pointing south. Still, price and wage growth remain too fast for the BoC to back off its hawkish rhetoric just yet. To act on that hawk talk would take either a big rebound in growth, a renewed acceleration in inflation, or perhaps a considerably weaker Canadian dollar. We assume none of those forces will weigh in, and look for the Bank to remain on hold deep into 2024.

Jay Zhao-Murray, forex market analyst at Monex Canada

While the BoC acknowledged signs of slowing demand, disinflation progress in sub-components such as services ex shelter, and a narrowing in the breadth of inflation pressures, the persistence in core inflation metrics—which are tracking between 3.5% and 4% annualized—as well as strong wage growth have led them to retain their hiking bias, expressing worries that “inflationary risks have increased.”

Driving this inflation persistence has been rising shelter costs and an uptick in fuel prices. While the BoC will likely look through the impact of the latter, it notes that unlike in previous cycles higher mortgage costs are not being offset by falling house price-related components, which have also risen in sympathy this time around due to structural supply constraints and high demand.

Although we expect these inflation pressures to moderate as the economy moves into excess supply, it is unsurprising that the BoC didn’t take much confidence in this view as doing so would likely stoke expectations of earlier and more aggressive easing in markets. As growth conditions ease further and make the disinflationary process clearer, however, this hawkish message will become an increasingly difficult sell to markets.

In the immediate reaction to the release, the loonie weakened by a quarter of a percent to reach its lowest level since March, while short-term yields fell by about 5bps yet remained higher on the day. Clearly, the market has viewed this as more dovish than expected, particularly due to the acknowledgement of clearer downward pressures on demand. While slight CAD weakness was foreseeable due to the residual risk of a hike priced into markets, the loonie has weakened further than we would have expected.

Brooke Thrackray, research analyst at Horizons ETFs Management

Now that inflation is showing some signs of moderating at lower levels compared to a year ago, the longer that the Bank of Canada maintains a 5% rate, the greater the impact that the rate will have on slowing the economy.

The economy is already stuttering with the Q2 GDP Growth Rate unchanged from the previous quarter. The Bank of Canada is trying to walk a fine line fighting inflation without tipping the economy into a recession. The Bank of Canada Governor Tiff Macklem may shift to a more dovish stance at the next meeting if the unemployment rate starts to move higher. The unemployment rate has remained unchanged at 5.5% for the months July, August and September. The next batch of unemployment data for Canada is set to be released on Friday November 3. If the unemployment rate shifts higher watch for the Bank of Canada’s tone to become more dovish at its next meeting on December 6.

Jimmy Jean, chief economist and strategist, Desjardins Securities

The Bank’s GDP forecasts are still above our expectations for the second half of the year and for 2024 ... and after being overly optimistic earlier this year, the Bank could still see economic activity come in weaker.

On the inflation front, the Bank points to a protracted battle, in part due to stickiness in the shelter space. Despite some recent deceleration in food prices, the broader picture remains that the timeline to 2% remains distant, and numerous upside risks to inflation persist in the interim. These include high inflation expectations, slow-to-improve price-setting dynamics, rent pressures, and geopolitical tensions. Consequently, it would have been imprudent for the BoC to offer any guarantee as to the end of rate hikes or the timing of rate cuts. It doesn’t appear unreasonable to think that the BoC will maintain a hawkish forward guidance until the very moment it decides to cut interest rates, if only in an attempt to keep a firmer grip on domestic financial conditions.

Canada’s economic momentum is fading nonetheless and the Bank observes that the labour market has been loosening. We believe the progress made on inflation across a number of dimensions (breadth and skewness), as well as the still muted hiring and wage hike intentions, can be seen as encouraging developments. They also coincide with the intensification of lagged tightening effects, QT, and the significant rise in longer-term bond yields globally, which have taken domestic interest rates along for the ride.

Claire Fan, economist, Royal Bank of Canada

With CPI readings still running well above the 2% target, the BoC is firmly focused on getting inflation under control. Slower than expected progress is a concern. But evidence continues to build that interest rates are already restrictive enough to continue to cool the economy, and alleviate price pressures. Indeed, consumers in the coming quarters are expected to further cut spending as more of them contend with rising borrowing costs. A weaker global economic backdrop is also expected to slow export and investment activities with Canadian businesses, who are already facing tighter financial conditions following a rise in longer-maturity bond yields. The BoC will be cautious about starting to ease off the monetary policy brakes too quickly - we expect the overnight rate will be held at 5% through the first half of next year, with modest rate cuts to follow starting in Q3 2024.

Tiffany Wilding, economist with PIMCO

Overall, their statement painted a picture broadly in-line with our view that the Canadian economy remains weak as tighter monetary policy continues to drag on activity but that there are risks of stagflation as strong population growth continues to lift housing services prices due to a lack of inventory and a (so far) muted supply response. We continue to expect [5%] to be the terminal rate [maximum the BoC will hike rates to this cycle]; however, the risk of more hikes still remains if wage inflation, inflation expectations and excess demand don’t cool further in the coming quarters.

Bryan Yu, chief economist, Central 1 credit union

We think today’s hold was the right decision and in line with our view that this rate hike cycle has concluded, despite the hawkish tone, and some inflation risks around wages and shelter. We anticipate further cooling in the economy as rates further curb consumption, housing, and investment. While the Bank’s upward forecast revision for inflation suggests a higher for longer stance, we are still of the view that the Bank could cut rates later in the second quarter.

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