What the Bank of Canada’s jumbo rate cut says about the economy — and what will happen next #CanadaFinance
CashNews.co
It’s not often that the Bank of Canada decides to make a “jumbo” rate cut, but that’s exactly what it did last week when it cut its policy rate by 50 basis points to 3.75 per cent. A “jumbo” or “oversized” rate cut is a term used to describe moves of more than 25 basis points. Usually, jumbo cuts come when the bank has urgent concerns about economic growth and wants to quickly encourage economic activity, but that is not always the case. So why did the Bank of Canada go big last week, and what usually happens next? The Financial Post explains.
The Bank of Canada usually takes an incremental approach to interest rate moves, preferring 25 basis-point steps, both up and down, to give its monetary policy decisions time to work through the economy.
However, the central bank will not hesitate to pull the trigger on a larger move if needed. Reasons for larger-than-normal moves in the past have included negative or stalling economic growth, emergency situations such as the pandemic, or a surge in inflation. For example, when price growth began to accelerate in the summer of 2022, the Bank of Canada raised its policy rate by 100 basis points in July. It was followed up by another hike of 75 basis points that September.
If things are urgent enough, it can even call emergency meetings to introduce faster cuts or hikes, as it did in March 2020, when then-governor Stephen Poloz brought the overnight rate down from 1.75 per cent to 0.25 per cent in the span of just one month through a series of jumbo cuts.
As noted, the most recent example of the Bank of Canada cutting big was at the outset of the pandemic, when Canadian and global economies slowed rapidly due to COVID-19 lockdowns.
In March 2020, GDP contracted by 7.2 per cent, followed by an 11.6 per cent drop in April. At the time, the central bank was worried about deflation, and brought the policy rate to a “crisis-level” low through several jumbo cuts to ensure a strong foundation for growth when the lockdowns ended.
Similarly, in December 2008, during the global financial crisis, the Bank of Canada chopped its policy rate by 75 basis points, bringing the rate down to 1.5 per cent from 2.25 per cent. The decision was made after economic activity contracted more than the bank initially anticipated, forcing it to acknowledge that Canada “was entering a recession.” The decision was followed by two back-to-back 50-basis-point cuts in the first quarter of 2009.
The only other time the central bank slashed by 75 basis points was in the fall of 2001, in the wake of unprecedented economic uncertainty following the Sept. 11 attacks.
Historically, then, jumbo rate cuts have usually been a sign that downside risks in the Canadian economy are spiking, with the possibility of a major downturn to follow.
Though the Bank of Canada has been signalling increased concern about downside risks to inflation and economic growth since the summer, many economists believe that last week’s jumbo cut, at least for now, is less about a looming economic catastrophe and more about playing catch-up.
After rapidly hiking interest rates to levels that restrict economic activity in a bid to tame surging inflation, the central bank, they argue, has fallen behind the curve in restoring Canada’s policy rate to a neutral level.
With headline inflation rising by just 1.6 per cent in September, below the central bank’s two per cent target, they argue the policy rate should be somewhere between 2.25 to 3.25 per cent.
Desjardins Bank chief economist Jimmy Jean is one of those who sees this cut as a catch-up move.
“They don’t want to convey a sense of panic, this wasn’t a move that was motivated by serious concern,” Jean said. “I think this is a different context, where you don’t have anything in the economy flashing red right now.”
While growth remains weak and the unemployment rate remained elevated at 6.4 per cent in September, there are few signs that an economic contraction is imminent.
Bank of Canada governor Tiff Macklem has said the economy remains in excess supply and that he would like to see growth pick up more. As the policy rate makes its path back to neutral, the central bank is hoping slumping household spending will pick up again going into next year, with a 50-basis-point cut sending a strong signal to consumers.
“Today’s interest rate decision should contribute to a pickup in demand,” Macklem said, during a press conference for the rate announcement.
With the next monetary policy decision over a month away, economists remain divided on whether the bank will follow up its October decision with another jumbo rate cut.
While some think another 50 basis-point cut is guaranteed for December, others think the central bank will take a more cautious approach, returning to a 25-basis point move.
Jean believes the central bank will cut by 25 basis points in December, and bring the policy rate into neutral territory by the first quarter of next year. Jean argues getting to neutral six weeks earlier with more aggressive cuts does not make a whole lot of difference, though he concedes the possibility remains that the central bank could make a steeper cut.
“They might have to cut more if say the U.S. election outcome suggests Canada’s economy faces significant downside risks,” said Jean. “Or if they integrate the federal government’s announcement on population because they were out with a very strong forecast for population growth of 1.7 per cent and now the government is saying that it’s actually going to be minus 0.2 per cent.”
When asked last week whether he plans to cut more aggressively in December, Macklem said he’s not going to “handicap the next move.”
“The timing and the pace is going to depend on how the data evolves, what we see, and what we think is needed when we get there,” he said. “We’re going to get a fair amount of information between now and December and we’re going to take our December decision in December.”
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