Hidden Bank of Canada clues point to another big cut: CIBC economists

Various signs point to the Bank of Canada (BoC) cutting interest rates by another half a percentage point in December, although the bank has not said so explicitly, CIBC economists say.

A research note, authored by economist Ali Jaffery and published this week, offers ways to “read the tea leaves of this easing cycle.” It identifies patterns in the BoC’s language and behavior that may define its intentions despite its “cautious communication approach”.

In addition to cutting the overnight rate 50 basis points to 3.25 percent at its Dec. 11 announcement, CIBC also expects the BoC to bring rates to 2.25 percent by mid-2025, “slightly below ” the neutral interest rate.

The federal government’s proposed GST deferral and spring rebate controls are “not material enough” to change projections, CIBC chief economist Avery Shenfeld told Yahoo Finance Canada in an interview. Other banking economists have disagreed about the potential impact.

In the research, Jaffery first notes that the “size and direction” of the BoC’s policy action appears to reflect how closely inflation and GDP data match its projections. Generally, if the data is more surprising, the BoC’s response is more pronounced.

In recent months, inflation has fallen “faster than the BoC expected,” Jaffery writes – falling an average of 0.2 percentage points more than the BoC’s forecast in three monetary policy reports. “It’s not massive, but it’s significant,” Jaffery says, noting that from 2012 to 2019 the BoC “never had three consecutive unilateral errors,” with the average difference between forecast and observed inflation close to zero.

Jaffery goes on to observe that the BoC “seems to put more weight” on Canada’s economic performance to GDP-based data than labor-based data. “This is evident from the fact that they place so much emphasis on the GDP-based output gap as their main measure of slack and publish no real-time forecasts for any labor measure,” he writes.

With that in mind, the research notes that the latest GDP-based data shows “material slack in the economy”, providing another clue to the BoC’s thinking.

The bank also considers various economic risks that are not as easy to model or examine, Jaffery writes, “such as how house prices will respond to interest rate cuts or how geopolitical forces affect Canadian inflation.” Although BoC Governor Tiff Macklem has described upside and downside inflation risks as “reasonably balanced”, CIBC claims the language used in the BoC minutes says otherwise.

Using an “in-house artificial intelligence tool”, CIBC analyzed the BoC’s deliberations and found that downside risks have received increasing attention. “Discussions of downside risks peaked in September, anticipating the 50bp cut in October,” the research says.

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