Traders lighten bets on June rate cut: How markets and economists reacted to the BoC decision

Market bets for when monetary easing will arrive in Canada fluctuated widely in trading Wednesday morning as the nation’s central bank kept its key interest rate unchanged and provided its latest guidance on what may lie ahead.

Implied probabilities in swaps markets following Bank of Canada governor Tiff Macklem’s press conference suggest about a 58 per cent chance of a rate cut in June, according to Refinitiv Eikon data.

That’s down from about 70 per cent odds coming into today.

However, immediately after the 945 am ET policy statement markets started pricing in only about 42 per cent odds of a June cut. Those bets quickly rose again during Mr. Macklen’s press conference, in which he told reporters that a June rate cut was still “within the realm of possibilities.”

For July, markets are now pricing in odds of a cut at about 79 per cent, similar to where they stood coming into today.

The central bank’s decision arrived shortly after the U.S. released higher-than-expected inflation figures at 830 am ET. The data sent the U.S. dollar spiking, pushing the Canadian currency down about half a cent US, and it slipped further later to a four-and-a-half month low to below 73 cents US. Bond yields in both Canada and the U.S. rose sharply after the U.S. data and at last check two-year yields were up about 18 basis points - a large one-day move. Canada’s five-year yield was up 14 basis points at 3.732%, nearing its high of February. All this suggests fixed mortgage rates will see some upward pressure in the days ahead.

Stock markets in both the U.S. and Canada immediately tumbled as the U.S. inflation numbers were released. Traders are now assigning only about 10 per cent odds that the Federal Reserve will start cutting rates in June.

The Bank of Canada kept its key rate unchanged at a near 23-year high of 5 per cent and ruled out a cut until it sees more signs that a recent drop in inflation will be sustained. In its quarterly Monetary Policy Report, the bank also hiked its growth forecast for 2024.

The following table details how swaps markets are pricing in future moves in the Bank of Canada overnight rate, according to Refinitiv Eikon data as of 1121 am ET Wednesday. The current Bank of Canada overnight rate is 5 per cent. 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.

And here’s how markets were pricing in monetary policy changes late Monday:

Here’s how economists and market strategists are reacting in written commentaries to the BoC decision and press conference:

David Rosenberg, founder of Rosenberg Research

The Bank of Canada quietly laid the table for rate cuts this summer at yesterday’s rate announcement — not as emphatically as we think they could have, but the forward guidance in the statement was there for anyone who took the time to read between the lines. Governor Macklem has set a clear threshold for cuts as soon as the June meeting: no reversal of the downward trend in core inflation. Gone are any references to what needs to happen to shelter costs, the housing market, or wages, for the Bank to ease policy. We’re now just a few good monthly core prints away from a cut. ....

Taking Wednesday’s meeting together with the hawkish (over)reaction to Wednesday’s U.S. CPI print points to a widening divergence between the U.S. and Canadian rate outlook, in turn, suggesting more and sustained Canadian dollar weakness. In fact, betting on GoC bonds and against the loonie might be the easiest way to invest around the U.S. economy’s current economic “exceptionalism” relative to its G7 peers, particularly its closest neighbor.

James Orlando, director and senior economist, TD Economics

The BoC remains steadfast in its desire to maintain rates at the current 5% level. It can justify this stance based on its upgrade to economic growth, while still expecting inflation to remain somewhat elevated over the coming months. This economic backdrop (alongside an upgrade to the neutral rate) affords the central bank more time to observe how inflation evolves, allowing it to gain greater confidence that price pressures have been tamed before it decides to cut its policy rate.

Market pricing is still holding onto hope for a June cut but July (our call) is becoming more likely. Even though inflation has moved within the BoC’s 1% to 3% target range over the last few months, markets have become more cautious on the timing of cuts. While some of this is coming from the inflation warning in recent U.S. CPI prints, strong Canadian economic growth to start 2024 has been the main driver. And while spending data have been encouraging, we question how long this will last, especially with the labour market having started to come under pressure in March. Should economic growth weaken further and inflation remain on its current trajectory, we could see the BoC readying markets for the cuts in short order.

Derek Holt, vice-president, Scotiabank Economics

Clearly when the Governor says that June is basically a ‘live’ meeting then that’s material information. When asked directly about whether a cut in June was within the realm of possibilities he said:

“Yes, it’s in the realm of possibilities. We’ve been pretty clear we like what we’ve been seeing since January. Inflation and core inflation have come down. Things are moving in the right direction. We’re encouraged by that progress. We need to see that progress continue. If things evolve broadly in line with the outlook we published today then we will be more confident we are on the right path and it will be more appropriate to cut our interest rates.”

In my opinion, a cut in June requires absolute perfection between now and then which means there is a material risk that Macklem was somewhat careless today. Like no crazy Spring housing market when the signs point toward a robust season. That Freeland doesn’t ramp it up next week and add more growth upside in yet another expansionary Budget before what will probably be another one in an election year next year. That the next two core inflation readings are soft when they might have been temporarily soft over the past couple of months. That Q1 GDP 5 days before the June decision doesn’t face further upside to their conservative estimate today. That the Fed doesn’t go less dovish or more hawkish after this morning’s CPI. That US CPI is irrelevant to Canadian CPI. That oil stabilizes. And that CAD doesn’t totally crater.

Piece of cake, huh?! Hmph. I’ll believe it when I see it and think there is high risk of another policy error.

One possibility is that if they do cut in June—whether or not the data goes their way—and if Fed cuts are pushed down and out, then maybe that’s it for the year. Or one more. Markets are basically saying they’ll only cut twice this year and so they’re leaning in that direction. Leaning, in other words, in the direction of only token easing because they’re not buying the case for a whole lot to be done this year.

What I’m conveying is that I would be really careful toward pricing the path after June especially if it turns out to be premature which I think it strongly risks becoming. Governor Macklem’s BoC has been a walking policy accident throughout his tenure in my opinion by ignoring all the signs of soaring inflation and then having to deliver bigger hikes than had he acted sooner. Prematurely easing now on the back of such remarkably thin evidence could be an extension of this track record.

So onto watching data. But remember, he only that said June was possible. It could very easily turn out not to be.

Nathan Janzen, assistant chief economist, Royal Bank of Canada

The BoC remains cautious about declaring victory over inflation prematurely, but an underperforming economy relative to other regions (particularly relative to the U.S.) and slowing inflation in recent months is edging policymakers closer to the first cut in interest rates. Governor Macklem was careful not to suggest a cut is imminent quickly, but also did not dismiss the potential for a cut at the next policy meeting in June. The BoC will get two additional monthly inflation reports, and one more monthly labour market report before the next scheduled policy decision and our own base case assumes a 25 basis point cut in June.

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

This suite of communications came broadly in line with our expectations, clearly reflecting what has been very encouraging inflation data in the last two months. While the statement doesn’t explicitly state that rate cuts are now on the table, this is effectively what was communicated, particularly in the press conference. Indeed, Macklem said they’re already “seeing what [they] need to see” when it comes to determining when rate cuts will be appropriate. They just need to see it play out for longer. That clearly puts June on the table for a potential cut (Macklem admitted as much in his press conference) with two CPI reports due to be released before that decision. That said, they’ve clearly left themselves plenty of flexibility if the data doesn’t remain as soft as it has been of late. By no means do we see June as a slam dunk for a rate cut. While policymakers are cautiously optimistic that inflation pressures will continue to subside, we have no doubt they’d delay the onset of cuts if underlying inflation were to re-accelerate. Simply put, incoming data will guide the June decision but at least policymakers are now willing to discuss lowering rates.

Royce Mendes, managing director and head of macro strategy at Desjardins

Overall, policymakers are seeing enough signs in corporate pricing behaviour, inflation expectations and wage growth to conclude that the disinflationary trend can continue even with an increase in expected economic growth this year.

The Bank of Canada raised its neutral rate estimate 25bps, but it’s still well below current market pricing. The new range of 2.25% to 3.25% continues to suggest that the central bank’s base case it to take rates back below 3.00%. Since the market is pricing in something above 3.50%, the new neutral rate estimate could actually be interpreted as a dovish doubling down that rates are going to fall more than what traders are pricing in.

The myriad of releases from the Bank of Canada paint a picture of policymakers who are nearly ready to begin a rate cutting cycle. ... We are retaining our call that the first rate cut happens in June. The only fly in the ointment today comes from outside Canada, with the hotter-than-anticipated US inflation numbers creating some concern that some price pressures could spillover the border.

Stephen Brown, deputy chief North American economist, Capital Economics

Governor Tiff Macklem sounded relatively dovish in the Bank of Canada’s press conference today, leaving the door open to an interest rate cut at the next meeting in June. While the Bank left the policy rate at 5.0% today, the policy statement and Governing Tiff Macklem’s accompanying opening statement to the press conference made it clear that the data are moving in the right direction for interest rate cuts.

Macklem said that “we are seeing what we need to see, but we need to see it for longer”. The definition of “longer” is open to interpretation. The monthly changes in the Bank’s preferred core measures, CPI-trim and CPI-median, have been consistent with the Bank’s 2% inflation target for just two months. Given that the Federal Reserve opted not to cut interest rates earlier this year, after more than six months of core PCE price data that were in line with its target, it might be that the Bank needs to see much more evidence before it is willing to loosen policy. But rather than push back, Macklem responded to a question about a June cut by saying that it is “within the realm of possibilities”. The big difference for the two central banks, aside from the more encouraging recent Canadian CPI data, is that the Canadian economy and labour market are weaker.

While the Bank still expects that it will take until 2025 for headline inflation to return to the 2.0% target, its forecast for inflation of 2.2% in the fourth quarter of this year is only marginally above our forecast of 2.0%. Moreover, the lingering difference compared to the 2.0% target will be largely due to still high mortgage interest costs inflation, which the Bank previously suggested it would be willing to look through. The upshot is that there was little today to make us doubt our forecast that the Bank will cut rates in June. The key risks to that view are that oil prices continue to rise, or that the recent US inflation data cause the Fed to start sounding more hawkish. We forecast that the Bank will cut interest rates by 25 bp at each meeting from June, taking the policy rate to 2.5% by mid-2025.

Andrew Grantham, senior economist, CIBC World Markets

Why rush? That seems to be the message from the Bank of Canada at the moment, as it once again kept interest rates on hold at 5% and appears to be moving only very slowly towards lowering interest rates. ... The fairly neutral tone of the statement shouldn’t be a big surprise as the Bank needed to justify why it didn’t start cutting interest rates today. Within the Monetary Policy Report, we saw the near-term increase in GDP and lowering of CPI forecasts that were necessary given the data flow since January. Even with higher oil price assumptions than in the prior MPR, the Bank still showed year-end inflation a couple of ticks below their prior assessment (2.2% vs 2.4%), which could be another sign that they are slowly moving towards being more comfortable about reducing interest rates. ... Overall, the statement is in line with a central bank moving slowly towards lowering interest rates, and sustained downward momentum in core inflation within the next CPI print will be key in determining whether than process can start at the next meeting in June. ...

We currently forecast a first interest rate cut in June and a total of four 25bp moves before the end of the year. To steal a line from Governor Macklem’s press conference today, that outlook still appears to be within the realm of possibility, but is reliant on core inflationary pressures sustaining their current lower rates or easing further

Benjamin Reitzes, managing director, Canadian rates and macro strategist, Bank of Montreal

The Bank of Canada was mildly more dovish noting the encouraging core inflation trend and softening labour market. However, policymakers need more evidence that this trend will continue before they’re willing to start easing. While June is still on the table, the coming CPI reports will need to be at least as good as what we saw in January and February. With the Fed seemingly on hold for potentially longer after a string of firm CPIs, the BoC will likely be a bit more cautious on the margin with rate cut timing. ... With this morning’s strong U.S. CPI, the BoC is going to have to keep a close eye on USDCAD. There’s a limit to how far the BoC and Fed can diverge and the C$ will be a big determinant of that. The last thing the BoC wants is to cut too aggressively, have the loonie tank, and spark imported inflation.

Jules Boudreau, senior economist, Mackenzie Investments

For a few months in the first half of last year, the Bank of Canada leaned towards rate cuts in its communications, before abruptly reversing its stance and hiking twice in the summer. As a result, there was a clear hit to its credibility. The Bank of Canada today showed that the scars from that experience are still fresh, when its statement refused to open the door to rate cuts in the near future. It won’t signal rate cuts before it is one hundred percent ready to cut.

The ingredients seem to all be assembled for the start of a slow, progressive rate cutting cycle. Monthly inflation has been trending around 1% annualized in recent months, core inflation around 2%. Economic growth has been sluggish, especially when adjusted for population growth. The job market is signalling a recession, with the unemployment jumping to 6.1% last month. But clearly the Bank doesn’t see it as such.

Even though inflation has been very low over the last few months, year-on-year inflation, at 2.8%, is still above target. Much of that elevated number is coming from high inflation prints in the second quarter of last year. Those will be coming out of the year-on-year inflation rate over the coming months. That could be enough for the Bank of Canada to open the door to rate cuts. Because of that, we think a rate cut in June is still a serious possibility.

There’s also the issue of our neighbour to the south. The Bank seems reluctant to begin cutting with the US economy booming, and US inflation stuck around a 4% trend, even if the Canadian reality is very different. Bank of Canada watchers will need to focus as much on the US economy as on the Canadian economy over the next few months.

Simon Harvey, head of forex analysis and Nick Rees, forex market analyst, Monex Canada

While holding rates against a body of evidence suggesting otherwise has hawkish implications, we think the BoC came across as notably dovish at today’s meeting. This was most visible in the Bank’s easing criterion. Policymakers no longer need to see a further easing in core inflation before cutting rates, as they said in January, but instead that “downward momentum is sustained”. Moreover, by holding rates at today’s meeting, the BoC will keep financial conditions tighter for longer. Based on our view that the Canadian economy is much weaker than the headline GDP data suggest, as evidenced by benign inflation conditions and firms’ hiring decisions, we suspect this keeps the bar low for the BoC to ease in June and successively thereafter.

Bryan Yu, Chief Economist, Central 1

While holding steady as expected, our view is that today’s statement and MPR is in line with a Bank of Canada cut as early as June. More progress on inflation is required, which will be contingent on further moderation in CPI trends going forward, and sustained easing of wage growth. We could see a delay if this does not occur. U.S. inflation and economic trends will play a significant role in how fast and deep Canada can cut. While the Bank is likely to move ahead of the Fed, wider deviation could put more pressure on the Loonie and stoke import price inflation.

Charles St-Arnaud, chief economist, Alberta Central credit union

The key message in today’s decision is that the BoC, while less concerned about inflation, is not yet ready to consider rate cuts. The Bank wants to see confirmation that the recent easing in inflation is sustained before easing. As we have pointed out on many occasions, the breadth of the inflation process, with about 40% of the CPI components still increasing at more than 3%, and the momentum in the BoC still above 3% are the main focus when it comes to inflation.

Overall, in our view, the tone of the Communiqué suggests that the BoC is close to declare victory in its fight against inflation. We believe the conditions will be in place by the June meeting for BoC to cut its policy rate. The BoC is unlikely to consider lowering its policy rate until the inflation is viewed as sustainably below 3%. This likely means that its preferred core inflation measures and their momentums are around or below 2.5%, which we do not expect until May 2024.

After that, the focus should turn to what will be the terminal rate in the easing cycle. As we have said repeatedly, and confirmed today by the BoC, the neutral rate is higher than pre-pandemic. This means that the extent of the rate cuts could be limited, meaning that interest rates are likely to be higher than pre-pandemic for a long period.