Canada’s Economic Outlook: Interest Rate Cuts and Modest Growth Ahead
The debate continues over the direction of Canada’s economy, as the Bank of Canada (BoC) faces critical decisions on interest rates. With recent gross domestic product (GDP) data showing mixed results, economists and financial markets remain divided on whether the central bank will opt for a 25 or 50 basis point rate cut at its next policy meeting on October 23. Meanwhile, Deloitte Canada’s fall economic outlook predicts a steady decline in interest rates over the coming years, with the BoC’s rate falling below 3% by mid-2025.
Mixed GDP Signals and Market Reactions
Canada’s GDP expanded by 0.2% in July, exceeding expectations, but preliminary data for August shows the economy stalling. As a result, third-quarter growth is now forecasted at an annualized rate of just 1%, significantly lower than the BoC’s July forecast of 2.8%. Despite this, financial markets have given a slight edge to a 50 basis point cut, with a 52.3% probability according to LSEG data, up from earlier expectations of a smaller reduction.
The U.S. economy is also playing a role, with easing inflation in the world’s largest economy creating more room for the BoC to lower its rates without putting downward pressure on the Canadian dollar. The U.S. Federal Reserve’s next meeting in November is expected to result in a rate cut, further influencing the BoC’s decision.
Economists remain split on the size of the upcoming cut, but many are leaning towards the larger 50 basis point reduction, citing weak GDP growth and rising unemployment, which currently sits at 6.6%.
Interest Rate Path and Economic Growth Projections
In line with this uncertain economic backdrop, Deloitte Canada’s forecast for the coming years suggests that the BoC will continue to lower rates to support economic growth. Deloitte predicts the key interest rate will fall to 3.75% by the end of this year, with further reductions to 2.75% by mid-2025. This 2.75% rate is seen as neutral, meaning it neither stimulates nor restrains economic activity, and is higher than the rates seen before the COVID-19 pandemic.
Dawn Desjardins, Chief Economist at Deloitte Canada, noted that while the economy has slowed due to higher borrowing costs, the country is likely to avoid a recession. “It’s hard to argue that the economy is just skating through this period of higher interest rates,” she said, but pointed out that growth persists despite these challenges. Desjardins expects economic conditions to improve next year, as more rate cuts help to stimulate demand.
Labour Market and Inflation Considerations
Canada’s labour market has shown signs of softening, particularly as homeowners begin to face the reality of higher interest payments when refinancing their mortgages. However, Deloitte remains cautiously optimistic, suggesting that the labour market is not in crisis, even though weaker job vacancy rates and hiring challenges persist.
At the same time, inflation has fallen to 2%, reaching the BoC’s target in August. With inflation seemingly under control, the BoC has shifted its focus to economic growth risks, particularly in light of weak GDP growth. Economists from various financial institutions, including BMO, Desjardins Securities, and CIBC, generally agree that more rate cuts are likely, with many favoring 50 basis point reductions in the near term.
Looking Ahead: Risks and Opportunities
While the economy has yet to fully recover from the pandemic’s effects, key factors, such as climate change, could increase inflationary pressures down the road, warns Desjardins. These structural issues are expected to embed themselves in prices and may affect future monetary policy.
For now, the central debate revolves around whether the BoC should accelerate its rate cuts in response to economic underperformance, or if it should take a more cautious approach, given ongoing uncertainties and the potential for economic resilience in sectors like housing and household spending.
In conclusion, Canada’s economic outlook for the next several quarters hinges on the central bank’s ability to navigate slowing growth and inflation risks. With interest rates likely to decline further, both the BoC and the broader financial markets will be closely watching the data to determine the best course of action to support economic recovery and stability.