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Summary
- We expect the BoC to cut its policy rate by 25 bps tomorrow.
- Despite a bearish consensus, we don’t see a further reduction in growth forecasts but appreciate the risks to the downside. That’s because we see green shoots in activity, hiring, and investment.
- Expect Gov Macklem to continue pushing the case for slower cuts as the BoC has approached its estimate of neutral.
- Tariffs remain the key risk, particularly if imposed for a prolonged period.
Market Implications
- We think it’s increasingly likely that the BoC cuts to 2.5% by December 2025.
- STIR pricing looks fair as the market is now pricing a 40% chance of a slowdown/ recession with CORZ5 at 97.35.
Canadian Economy Is Responding to Lower Rates
We expect the BoC to cut its policy rate by 25bp to 3.0% tomorrow, in line with consensus. The economy continues to show green shoots following two consecutive 50 bps rate cuts. Real incomes continue to grow despite slower nominal wages.
The BoC updates forecasts this month. We expect:
- The BoC forecast for Q4 GDP growth should stay the same at 2.0%. Stronger retail sales in December could allow the Q4 growth forecast to be met. The larger question is if it can be sustained into Q1.
- We expect the 2025 GDP growth forecast of 2.3% to remain broadly the same but feel risks are tilted to the downside.
- Headline inflation was lower than expected at 1.9% vs 2.1% Q4/Q4, largely due to the recent GST holiday. The BoC is likely to look through this.
- Core inflation has been firmer than expected at 2.6% vs. 2.3% Q4/Q4.
In Macklem’s presser, we expect three topics to dominate the discussion:
- Improving labour market dynamics, which may begin to absorb excess supply in the coming months.
- Downside risks to the economy stemming from broad-based tariffs on Canadian exports to the US.
- The firming of core inflation despite the economy retaining excess supply.
Therefore, we think STIR remains fairly priced as the BoC is unlikely to shift away from its current narrative of a more gradual pace of cuts after hitting the upper end of its neutral range. In other words, the BoC will maintain there’s no need to cut below neutral.
We think it is likely that the BoC will cut to 2.5% by December 2025 to ward off left-tail risks to growth. Since the last meeting, market pricing has increasingly reflected this with an implied probability of slowdown (rising from 30% to 40%) as CORZ5 has rallied to 97.35. Risks to the downside stem from tariffs being imposed for a sustained period.
