Bank of Canada expected to cut interest rates again! But still facing dual risks

At 21:45 Beijing time, Canada will announce its central bank interest rate decision until July 24th. Economists say that the Bank of Canada is likely to cut interest rates for the second time in a row, aiming to avoid an economic recession while preventing inflation from soaring again.

Bank of Canada Governor Macklem has previously stated that he believes a soft landing is imminent. Last month, the Bank of Canada became the first central bank in the Group of Seven (G7) to cut interest rates. Economists and the market widely expect that the bank will once again lower the key policy rate on Wednesday, from 4.75% to 4.5% . A soft landing refers to an economic slowdown that eases price pressures without triggering widespread unemployment.

Macklem's task will be to assure Canadians that despite obstacles ahead, the Bank of Canada remains on the right track.

The Bank of Canada faces dual risks. On one hand, while Canada's overall inflation indicators slowed in June, core inflation remains stubborn. On the other hand, Canadian mortgage holders still need to renew contracts at higher rates, and the Canadian government's efforts to limit temporary immigration will put consumers under price pressure.

Manulife economist Dominique Lapointe said in an email, "As long as the anti-inflation process continues, the Bank of Canada has a narrow path to achieve a soft landing, but this requires them to continue cutting interest rates."

For Macklem, the stakes are high. He faced criticism for promising Canadians in 2020 that rates would remain low for a "considerable period," and then for delaying rate hikes when inflation soared. However, when leading peers in rate cuts last month, Macklem showed confidence, and on Wednesday he may reiterate that the possibility of further rate cuts exists as long as price pressures continue to ease.

The Bank of Canada will also release a new round of economic forecasts, which may align with analysts' cautiously optimistic outlook in a Bloomberg survey. They expect overall inflation to slow from the current 2.7% annual pace to reach the bank's 2% target by the end of 2025, by which time the economy is also expected to grow at a 2% annual rate.

Macklem and his officials are unlikely to provide clear forward guidance, but are expected to reiterate their stance of making decisions at successive meetings after evaluating the upcoming data. They state that the path to rate cuts will be "gradual." Economists predict that by the end of next year, the key rate will reach 3%.

Nevertheless, two consecutive rate cuts, and much earlier than other central banks including the Federal Reserve, will raise questions about the Bank of Canada's plan to normalize borrowing costs at what pace.

Accelerating action will allow policymakers to act before upcoming mortgage renewals, reducing the impact on homebuyers who bought at historically low rates during the pandemic. However, cutting rates too quickly could potentially reignite cost pressures or stimulate a real estate market already facing supply constraints. After the interest rate decision in June, inflation data unexpectedly heated up. Although the next report showed a slowdown in overall inflation, the core indicator of the three-month moving average accelerated to 2.91%. This may make some policymakers hesitate. The minutes of the last meeting showed that they had debated whether more evidence of inflation slowdown was needed to ease policy.

However, cracks are appearing in Canada's labor market, with the unemployment rate rising by a full 1% from a year ago to reach 6.4%. Employment growth has failed to keep pace with the explosive population growth, partly driven by temporary residents such as foreign workers and international students.

Canadian Prime Minister Trudeau has taken steps to limit the growth of these immigrants and plans to set an overall limit on this group in the coming months.

Wage growth remains high, which poses a risk to inflation against the backdrop of low productivity (an indicator of per capita GDP). However, labor shortages have essentially disappeared, and officials may argue that this alleviates their concerns about wage pressures.

Last week, the quarterly business and consumer surveys closely monitored by the Bank of Canada showed a weakening in inflation expectations, with pricing behavior by businesses trending towards normalization.

Dawn Desjardins, Chief Economist at Deloitte, said in an interview, "All of this seems to be moving in the right direction, and I think it does indeed make them inclined to ease policy."