The intense volatility in global financial markets over the past week is swiftly affecting Canadian interest rate forecasts, causing them to drop like autumn leaves in a strong wind.
TD, CIBC, and BMO have taken the lead with their revised forecasts, all now anticipating that the Bank of Canada will reduce interest rates more quickly and significantly over the next 16 months.
What’s happening with global financial markets?
Market turmoil began in earnest early Friday, largely driven by developments in Japan and the U.S.
In Japan, concerns emerged from a shift in the Bank of Japan’s long-standing negative interest rate policy. On July 31, the central bank raised its short-term policy rate to 0.25%, the highest in 15 years, up from a range of 0-0.1%. This change led to a rapid unwinding of the yen carry trade, where investors had borrowed yen at low rates to invest abroad, causing a sharp selloff in Japanese stocks that eventually spread to global markets.
In the U.S., growing fears that the Federal Reserve’s high interest rates could push the economy into recession have emerged, with concerns that the central bank is not responding swiftly enough. Weak employment data and disappointing earnings from major tech companies have intensified expectations for imminent rate cuts, further destabilizing the market and causing a sharp decline in the U.S. 10-year Treasury yield.
As Canadian markets often follow trends in the U.S., Canadian bond yields also dropped to two-year lows, resulting in a new wave of fixed mortgage rate cuts.
The Bank of Canada is increasingly focused on downside risks
Adding to the situation, new insights from the Bank of Canada have bolstered expectations that rates are likely to decrease steadily in the near term.
The summary of discussions from the BoC’s July 24 monetary policy meeting indicated that the Bank is increasingly worried about downside risks to the economic outlook, rather than focusing on upside risks to inflation.
“The downside risks to inflation took on a greater importance in their deliberations than they had in prior meetings,” the summary reads, adding that the Governing Council is now placing “more emphasis on the symmetric nature of the inflation target.”
“Similar to the July Monetary Policy Report, the deliberations focused on downside risks to the consumer spending outlook, as a growing number of households renew mortgages at higher rates in 2025 and 2026 and labour market slack builds,” wrote Michael Davenport, economist with Oxford Economics.
“We share this concern and think that the wave of mortgage renewals and building job losses will cause consumers to cut discretionary spending in the near term. This should prevent a meaningful pick-up in consumer spending until the second half of 2025 and convince the BoC that more rate cuts are necessary,” he added.
Not everyone thinks the debate about the Bank of Canada’s rate cuts is a stark choice between slashing rates to avoid a recession or making no cuts at all. Instead, Scotiabank’s Derek Holt suggests that a more nuanced approach is needed.
Imagine navigating a boat through choppy waters. It’s not just about either speeding up to avoid a storm or anchoring down completely to stay safe. Sometimes, a skilled captain adjusts the sails and rudder to balance between speeding up and slowing down, depending on the changing conditions. Similarly, a balanced approach to rate cuts means carefully adjusting policies to manage economic risks without overreacting to either extreme.
“I’ve argued that easing is appropriate to re-balance the risks from significantly restrictive policy, but that the steps should be pursued carefully,” he wrote. “Cutting too fast and too aggressively with very dovish guidance risks resurrecting inflationary forces. The economy is resilient and inflation risk remains elevated, so be careful in crafting monetary policy.”
