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Bank of Canada Cuts, Telegraphs More Easing Ahead

The Bank of Canada delivered a long-awaited rate cut this morning, and language in the accompanying statement set the stage for more easing to come at subsequent policy meetings – a regime shift that should add to momentum pushing the Canadian dollar lower. In the official statement setting out the decision, policymakers said “Overall, recent data suggest the economy is still operating in excess supply,” and “has increased our confidence that inflation will continue to move towards the 2 percent target”.

Officials noted that consumer price growth has slowed, with three-month measures showing “continued downward momentum”. All of the Bank’s preferred indicators have moved back into the target range, and the Bank’s old measure of underlying inflation – the ex. mortgage interest cost “CPI-X” index – dropped to 1.6 percent year-over-year in April.

The Bank acknowledged slower-than-expected growth in the first quarter – the economy expanded at a 1.7-percent annualised rate in the first three months of the year – below the official 2.8-percent forecast, and the previous quarter’s print was revised down to 0.1 percent from the 1 percent pace initially estimated. But “consumption growth was solid at about 3 percent, and business investment and housing activity also increased,” with final domestic demand – sometimes considered a cleaner read of underlying aggregate demand growth – accelerating, following an earlier jump in retail sales numbers.

In prepared comments released ahead of the post-decision press conference, Governor Macklem acknowledged it would be “reasonable to expect further cuts to our policy interest rate,” but added caveats, saying that further easing would depend on growing “confidence that inflation is headed sustainably to the 2-percent target”. He said “We don’t want monetary policy to be too restrictive than it needs to be to get inflation back to target,” but “if we lower our policy interest rate too quickly, we could jeopardise the progress we’ve made”.

“Further progress in bringing inflation down is likely to be uneven, and risks remain,” Macklem warned, with global uncertainty, high wages, and a jump in house prices looming as potential risks that could slow progress.

Back-to-back rate cuts look unlikely at this juncture, but between now and the July meeting, officials will see two consumer price reports, two employment updates, new retail sales numbers, another month of growth data, and several key business and consumer surveys. The July decision will also coincide with the release of the Bank’s quarterly Monetary Policy Report, which offers policymakers an opportunity to more carefully calibrate household and market expectations for the easing trajectory ahead.

Although a change in tone is possible when Governor Macklem and Deputy Governor Rogers answer reporter questions in half an hour, today’s slate of Bank communications should help lift animal spirits in the Canadian economy, bolstering home buying, consumer spending, and investing activities.

The Canadian dollar has fallen roughly 40 basis points post-decision on a rise in easing expectations and a widening in near-term rate differentials relative to the US. We suspect that downward pressure on the loonie will continue in the near term, with the economy’s deeply-embedded rate sensitivities pointing to more easing ahead. Real monetary policy settings – as measured using the gap between the target overnight rate and the Bank’s preferred inflation measures – remain deeply restrictive in real terms, and Canada is facing little risk of a US-style re-acceleration in price pressures. With allowances made for differences in data interpretation, Taylor Rule-based analysis suggests that the target rate should converge with 4 percent over the next year.

Currency weakness could reverse of course, with a moderation in the Federal Reserve’s “high for long” messaging looking like the most likely proximate trigger for a reversal in the “divergence” trade that has propelled the greenback higher against most of its major rivals this year.

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