With the Canadian economy showing signs of slowing more than expected, all eyes are on the November jobs report, due Friday, for clues about the size of the Bank of Canada’s next interest rate cut. After a weak third-quarter GDP report, economists believe the jobs report could tip the scales between a moderate and aggressive cut. A weak report could prompt the Bank to engineer a second consecutive jumbo cut.
The central bank started its monetary easing cycle in June this year, and it has since delivered four overnight interest rate cuts, including a 50-basis-point reduction in October, bringing the policy rate from its peak of 5.00% at the beginning of the year to 3.75%.
FactSet forecasts that the Canadian economy added 22,500 jobs in November, an increase from October’s 15,000. However, the unemployment rate is expected to tick up only slightly to 6.7% from 6.5%, indicating a mixed picture for the labor market.
Jobs Report Pivotal to Rate Debate
As the economic outlook remains fluid, the labor market could significantly influence the final rate call. “A big downside surprise could tilt the scales in favor of a second consecutive 50-basis-point move,” says Royce Mendes, managing director and head of macro strategy at Desjardins Capital Markets. He favors a smaller cut but admits “the odds of a half-point cut have increased.”
BMO chief economist Doug Porter echoes this view. While he typically doesn’t put much stock in an employment report, he says that “given how close the call is between a 25- and 50-point cut, [the jobs report] may well be the deciding factor. The Bank will be closely looking at job growth, the unemployment rate, and the pace of wage growth to help inform its decision.”
Economic Slowdown May Add Urgency to Rate Cuts
The slowdown in Canada’s economy to a measly 1% GDP growth in the third quarter has intensified the argument for the central bank to deliver another 50-point cut to stimulate economic growth.
“The market has assigned much greater odds to a 50-basis-point cut in December in the wake of the soft GDP result,” says Porter. However, he states that while the market is pricing in increased odds of a half-point cut, “we still lean to the smaller move.”
Taylor Schleich, director of economics and strategy at National Bank of Canada, agrees with the current consensus that it’s “basically a coin toss between 25 and 50 basis points for the December rate decision.” He adds that the GDP numbers may justify a larger cut. The third-quarter data shows rates are still too high to generate a pickup in business investment, which he sees as a clear sign that policy remains too restrictive. “Another large rate cut would definitely encourage spending and investment, and this is exactly what the Bank of Canada would like to see,” he explains. “Since GDP is below potential, they’ll tell you Canada needs stronger growth to close the output gap.”
A key trend in the latest GDP report was the uptick in household consumption. However, Schleich thinks the numbers also reveal consumers aren’t spending to their fullest capacity. Furthermore. preliminary data for the fourth quarter does not suggest spending growth will return to its potential.
The Wrinkle of External Factors
Developments beyond Canadian borders, particularly in the United States, could be a contributing factor policymakers will watch while calibrating their next rate maneuver. “The pace of US rate cuts and the health of the US economy can also factor into the Bank of Canada’s decision, and our view is that these factors are leaning to a more cautious stance,” explains Porter.
There is also concern about US President-elect Doland Trump’s threat to impose a hefty 25% trade tariff on Canadian imports. “The trade uncertainty emanating from the US would also lean toward deeper rate cuts from the Bank of Canada, particularly if the proposed 25% tariff hikes are enacted,” Porter says.
Mendes raised similar concerns. “Trump’s threats will at the least weigh on business investment, even if the tariffs don’t materialize,” he says, alluding to the weaker business spending reported in the recent GDP report.
On another front, declining oil prices reduce policymaker concerns over inflation, potentially making a larger cut to tackle weakening economic growth more viable. Porter says, “Oil prices of less than USD 70 per barrel are taking the pressure off inflation and lean toward more rate reductions, all else equal.”
The Buck Drops
One unintended consequence of falling interest rates is the softening of the Canadian dollar relative to the US dollar. While the central bank wants to see growth pick up as a result of rate cuts, “the Canadian dollar would continue to soften,” asserts Schleich. He warns Canadians can expect to “see more downside for the loonie ahead.”
Monetary policy decisions south of the border also tend to affect the Canadian economy and by extension the loonie’s strength. For that reason, the pace of US interest rate cuts and the health of the US economy can also influence the Bank of Canada’s decision. “The [US] Fed is poised to slow the pace of cuts, and US growth and inflation have remained firm,” Porter points out. “In turn, this is putting downward pressure on the Canadian dollar, which makes it a bit tougher for the Bank of Canada to cut quickly.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
