The Global Week Ahead: BoC Preview—Be Careful What You Unleash

Next Week's Risk Dashboard

• Bank of Canada preview
• Why inflation risk is not dead in Canada
• How this could be a very different Canadian consumer cycle
• BoC expected to leave QT on auto pilot
• BC, NB go to the polls
• PMIs: Eurozone, US, China, UK, India
• Russia’s central bank expected to deliver another mega-hike
• IMF-World Bank meetings
• Global macro

Chart of the Week

A quieter week than normal combined with the importance of this particular Bank of Canada meeting will have me dedicate this issue of the Global Week Ahead to assessing what the BoC may do now, in future, and what I think is the direction of risks stemming from this easing cycle by contrast to other easing cycles. It is a different narrative than you are likely to hear compared to all the Canada gloom that’s out there, but it comes at the price of being very careful toward the size and pace of rate cuts given idiosyncratic factors unique to Canada.

Other considerations will include the October IMF-World Bank meetings in Washington that will attract central bankers and Ministers of Finance as the IMF presents a refreshed set of forecasts. A pair of Canadian provincial elections will unfold before the BoC. Global data risk will be fairly light. The only other central bank to deliver a decision will be Putin’s.

BANK OF CANADA EXPECTATIONS—MORE BANG TO RATE CUTS THIS CYCLE?

The Bank of Canada delivers a policy statement and freshened Monetary Policy Report including updated forecasts on Wednesday at 9:45amET. It will be followed by a press conference hosted by Governor Macklem and Senior Deputy Governor Rogers forty-five minutes later.

A 50bps rate cut is expected. 25bps would be preferred, but I would assign 65% odds to a 50bps cut, 25% odds to a quarter point, and the residual 10% odds to the risk of an even bigger cut.

50bps would take cumulative cuts to date to 125bps and leave the policy rate at 3.75%. Our forecast is marked by considerable uncertainty in both directions, but at this point we think the rate will decline to 3% by Spring and stay there throughout the rest of 2025 as the nearer-term terminal rate. That would bring the rate into the BoC’s currently estimated neutral rate range of 2.25%–3.25% with a 2.75% midpoint (chart 1). The neutral rate speaks to equilibrium conditions in the economy absent shocks and is a longer-term guidepost. Chart 2 shows our forecast compared to consensus and market pricing.

Governor Macklem is likely to repeat the line that it is reasonable to expect further rate reductions and otherwise let his team’s forecasts do the talking on the bias. That bias is less data dependent now than it is driven by a quest to normalize rates.

We do not expect changes to balance sheet management.

Forecast revisions for Canadian growth and inflation are expected to be relatively modest compared to the BoC’s July MPR and our current BNS Economics forecasts (chart 3, 4). In essence, there is a whole lot of consensus hugging going in the Canadian forecasting community. Where the BoC will have to revise its projections is more around near-term growth as they are likely to revise down their prior 2024Q3 growth projection from 2.8% to more than a percentage point weaker. They could leave the rest largely intact.

What follows is a rundown of more detailed expectations and drivers.

1. UNCHANGED QT

The BoC’s balance sheet management plans are expected to be unchanged. That means an ongoing preference toward allowing full roll-off of maturing holdings of Government of Canada bonds from its balance sheet. The quest is to normalize the balance sheet by reducing holdings of GoC bonds in a cleaner balance sheet dominated by them, while reducing settlement balances—deposits held at the BoC by members of Payments Canada—to the BoC’s stated goal of $20–60 billion. The BoC remains far away from both goals and prefers to communicate in advance of any balance sheet shifts.

The pace is dictated by the lumpy profile of maturing holdings shown in chart 5.

Chart 6 shows how this translates into projected levels for BoC GoC bond holdings over coming years assuming no other changes. Chart 7 does the same thing as a share of nominal GDP. Present holdings stand at about C$218B. If full-roll-off persists, then the BoC’s holdings would only return toward pre-pandemic levels by the turn of the new decade. 

Scaled to GDP, however, GoC holdings could arrive at pre-pandemic levels by 2028 assuming NGDP growth of about 4% per year (2% inflation, 2% real growth).

Settlement balances—the analog to reserves in the US banking system that are held at the Fed—presently sit at about C$120 billion which is double the upper limit of the BoC’s $20–60B target range.

That range may be too low. Chart 8 shows the balances as a share of NGDP; as a share of NGDP it is vastly lower than the Federal Reserve’s target range. That could be because what the Federal Reserve does spills over into Canada to its benefit by propping up liquidity in a North American capital market. It could also be because of the sentiment that Canada is special relative to the US including a more stable banking system. Among the counters to this claim is that a higher-beta market sells off more than the US in the face of shocks and changes in risk tolerance which may necessitate more of a liquidity buffer.

In any event the BoC’s interpretation of the persistent spread between market pricing of the policy rate (CORRA) and the administered policy rate (chart 9) is that it is driven by an increase in speculative long positions requiring repo market financing including around expected rate cuts (here). 

Because of this, the BoC has tended to reject a role being played by its QT plans in widening this market spread which imperils its ability to steer the short-term rates complex toward its policy rate. This is why it has opted for other balance sheet management tools—or the threat of using them—such as repo operations, receiver general auctions and cash management bills.

The persistence of the CORRA market rate overshoot to the policy rate dates back to August 2023. I find it a stretch to argue that the BoC’s QT plans have played no role in driving a persistent spread throughout the whole period in which rate speculation has ebbed and flowed with markets now aggressively priced for easing. Whereas a literal interpretation of the BoC’s projected settlement balances and GoC bond holdings would suggest that tapering and ending QT may be a long way off, I lean toward this becoming a more pressing matter for the BoC to address over 2025.

2. THE FIRST MEGA-CUT OUTSIDE OF A CRISIS?

In addition to not seeking tighter financial conditions by delivering a smaller cut than the 50bps that is largely priced, the case for upsizing the size and pace of BoC cuts centers around two main reasons. One is excess capacity in the economy measured by a negative output gap that indicates supply exceeds demand which is one driver of disinflationary pressures (chart 10). Second is that the preferred measures of core inflation are on the BoC’s 2% headline inflation target in m/m terms at a seasonally adjusted and annualized rate (chart 11). Excess capacity and recently decelerating core inflation are likely to shift the BoC’s attention toward the rising risk of undershooting its 2% inflation target. If so, then this merits a quicker pace of rate cuts in isolation of other arguments.

The first counterargument to this is shown in my colleague Jay Parmar’s chart of the week on the front cover to this publication. It shows that the Bank of Canada tends to only deliver upsized rate cuts (more than 25bps) during crisis points. That’s been the experience so far this century. Cuts of 50bps or more were confined to the dot com and GFC periods. Absent a crisis, upsizing can invite volatility and erratic policy guidance and actions as the Federal Reserve has discovered since its 50bps cut in September.

Is this a crisis? Not in my books. Not in the slightest. The constant gloom that is pumped by our competitors is exaggerated and unhelpful. The narrow, insatiable self-interest of the most vocal supporters of aggressive easing in the real estate sector is not considering the broader ramifications. This is an economy that has been remarkably resilient in the pace of a nearly five percentage point rise in short-term borrowing costs. If there is an emergency, then it would lie on the other side of overly aggressive easing by the BoC that validates market pricing if not going beyond.

Why that’s the case is the focus of the next section. The economy’s response to falling rates is arguably going to be much more powerful than in the past, such that reliance upon macroeconometric models that derive growth sensitivities from historic tendencies are at risk of underestimating the effects.

3. WHY INFLATION RISK HAS NOT GONE AWAY

Leverage works in both directions during a monetary policy cycle.

Today’s more leveraged household sector than in the past and compared to other countries has cost Canada some growth over the period during which the Bank of Canada began sharply raising its policy rate starting in March 2022. It hasn’t been the only explanation of tepid growth given a multitude of shocks (strikes, wildfires, pandemic restrictions, productivity, retooling and maintenance activities in key sectors, etc), but it has been a major one. Canada has been unable to generate quick enough income and productivity gains to compensate for the effects.

Leverage cuts both ways, however, such that by the same principle, a more leveraged household sector is likely to see more flow through of rate cuts into spending than less leveraged household sectors elsewhere, such as the US. You can’t have it both ways by estimating underperformance by the household sector and broader economy in both rising and falling interest rate environments.

This recent period of growth underperformance has created pent-up demand relative to supply shortfalls that counsel against using long-run rate sensitivities for household demand versus cyclically boosted sensitivities. Spending and homebuying were deferred in a higher rate environment. Canadian consumption went down harder than it did in the US and climbed more slowly as the pandemic hit—and in its aftermath (chart 12). Buying intentions show a significant amount of pent-up housing demand (chart 13). At the same time, supply will fall short in serial fashion. The Government of Canada’s homebuilding targets are laughably unachievable; Canada would have to nearly triple its annual pace of homebuilding and do so every year throughout the rest of the decade into the early 2030s to hit them. Immigration and affordability challenges have driven upward pressure on rent that faces more favourable ownership conditions in a falling rate environment.

Of course, households need to have the means to fund the release of this pent-up demand. One mechanism for achieving this is rate cuts themselves. Another is that for years now—including at present—Canadians have been saving in ham fisted fashion. The personal saving rate of about 7¼% is about 4¼% above the US personal saving rate. The cumulative rolling amount of savings above what an extrapolated trend line would have predicted sits at about half a trillion dollars (chart 14). This doesn’t include gains in wealth derived from investments in stocks, bonds, and real estate net of changes in debt; using net worth relative to a trend line shows about C$2 trillion in net worth above a trend line (chart 15) and as argued here it is spread across all income cohorts.

Some of this idled savings is due to precautionary demand amid uncertainties, some is due to an aging population with an eye on retirement and some may be due to the small share of households most pressured by mortgage resets.

Much of it, in my opinion, reflects the role of high interest rates that discouraged consumption.

In summation, more debt than in the past coupled with aggressive rate cuts, excess savings, and pent-up demand risk a larger than usual response by consumer spending and housing demand to monetary easing than in history. Models rooted in the past will not capture this, yet the BoC is using just such models.

As an illustration of how this could matter, chart 16 shows two scenarios for how the output gap is expected to evolve. One is our model’s base case that shows the output gap persisting with GDP growth of between 2.1–2.5% q/q SAAR throughout 2025 which is in our base case. The other scenario shows that the output gap would shut if growth was a mere 0.2 q/q SA percentage points faster than we project per quarter on average in nonannualized terms throughout 2025. The result would be full closure of the output gap by the end of 2025 under the same assumptions used by the Bank of Canada for how potential GDP evolves. In this scenario, it’s feasible that the economy begins to push into excess aggregate demand again into 2026 which would mean that the output gap turns toward driving more inflation risk.

It would not take much to get that kind of growth overshoot to our forecasts. It would likely require consumption to grow materially faster than our tepid 1.6% model-based base case next year that matches consensus, and for housing investment to rebound by more than our 5% projection. That may not be hard to do at all under the conditions that are outlined above. In fact, projected base case consumption derived from our model is the weakest pace of consumption growth since 2009 excluding the immediate effects of the pandemic (chart 17), yet it is occurring in the context of aggressive policy easing.

The catalysts to this narrative about inflation risk don’t stop with households.

4. OTHER DRIVERS OF INFLATION RISK

Fiscal policy in Canada continues to prime the pump. Years after the emergency has passed, fiscal policy remains stimulative. Even if the upcoming Fall Economic Statement offers no new initiatives, the Federal Government will still be adding more spending into the economy year after year for many years to come as a by producer of the expensive programs they will continue to roll out (chart 18). Canada will hold an election no later than next October and I still think that a government that is severely down in the polls is likely to engage in expansionist fiscal policies just as governments of all stripes do.

Then layer on the provinces. Ontario’s election must occur by June 2026, but signs point to an early election. Conservative Premier Ford’s vote-grabbing promise to give every one of the province’s 16 million residents a $200 cheque is obviously about populist politics probably on the path to an early election and is likely to be accompanied by a more expansionary Winter budget. Alberta’s conservative government is adding more spending, as are other provinces that have abandoned fiscal restraint such as manifested by this coming week’s provincial elections.

Wage growth in Canada continues to outpace inflation throughout the whole pandemic era which invalidates the make-up pay defence (chart 19), while labour productivity has continued to tumble (chart 20). The combined effects squeeze corporate profit margins and some of that effect gets passed onto various stakeholders from shareholders to government tax revenues—and consumers.

Corporate balance sheets are healthier than they’ve been in decades (chart 21). Canada suffered massive job losses coming off the late 1980s for multiple reasons—rates being one of them—but an added one was the impaired state of corporate balance sheets. Today’s economy has been relatively less rate sensitive in part because of healthier corporate balance sheets that did not incite the same degree of downsizing panic.

Structural inflation drivers that will probably be with us for many years entail acknowledging that global supply chains are at a highly nascent stage of change. For years, companies outsourced to the local cost jurisdictions without having to worry about financial distress costs including not being able to get product and outright bankruptcy should border barriers flare. The rise of protectionism, geopolitical risk, shipping costs and challenges to key routes, the pandemic, and environmental trade barriers have thrown out this one-way outsourcing model. Supply chains are likely to continue to adopt higher levels of inventories and greater concentration near key markets. That doesn’t happen overnight. Just as China’s accession to the WTO took two decades to have its full disinflationary effects, the changes over recent years are likely to have their influences in passing on higher costs of more expensive supply chain management for a long time yet.

It’s also feasible that the BoC would be wrong to harp on weak per capita GDP growth. This is being driven by excessive growth in the temporary resident category of immigration in addition to long-term weakness in productivity. Removing the temporary resident category yields a stark difference in GDP per capita trends (chart 22). There are two reasons for doing so. One is that the federal government is tightening this category of immigration to some effect so far (chart 23) and this will likely drive population growth to around 1% y/y next year and in 2026. Another reason is that temps—comprised of international students, temporary foreign workers, and asylum seekers—represent a transient population that should not be expected to contribute to GDP levels in proportionate terms to others at least until the ones who stay become more integrated into the economy.

5. OTHER UPSIZING CONCERNS

The case against upsizing and aggressively cutting thereafter goes further yet.

Save upsizing for potentially more exigent circumstances, like an uncertain shock or the consequences of the US election or market dysfunction.

the bond market does not need to be jolted with an outsized move. Canada’s 2-year GoC yield of about 3% and the roughly 2.9% 5-year yield are already primed for cutting toward the neutral rate range. The FOMC might have felt a need to jolt bonds with the US rates curve still well above Canada’s, but that’s not the case for the BoC.

With markets already aggressively priced for easing, up-sizing even just once would have markets price another up-sized move and perhaps more. The BoC may not be comfortable with being pushed into this position by markets while presenting the risk of having to disappoint markets at some point. This should matter to Governing Council, though it tends to be aloof toward markets.

The BoC’s forward guidance has said the path down wouldn’t be the same as the path upward. This means that the big hikes wouldn’t be followed by out-sized cuts and hence the paths up and down would not be symmetrical to one another. The BoC’s forward guidance has performed poorly over the years and violating current guidance would do nothing to improving guidance while further damaging its credibility.

Up-sizing cuts could be treated as a case to raise inflation forecasts over 2025–26 and potentially introduce erratic monetary policy over time.

While I don’t think the connection to politics is clear, aggressively cutting ahead of a Federal election could put the BoC into the political crosshairs and with its next inflation renewal agreement with the Federal government due in 2026 before Governor Macklem’s term expires in 2027.

Chart 24 shows how the yield curve is expected to evolve as markets increasingly look ahead.

PROVINCIAL ELECTIONS—BC AND NB

British Columbians go to the polls this Saturday ahead of New Brunswick’s election on Monday. Attempts at translating polling into seat projections show that the BC conservatives lost ground this month (chart 25), while the Liberals and Conservatives are locked in a tight race in New Brunswick (chart 26). Last week’s Global Week Ahead had more on the BC election here.

GLOBAL MACRO—THIS AND THAT

Chart 27 shows the line-up of other global indicators over the coming week. 

The main data focal points will be purchasing managers’ indices from Australia and Japan (Wednesday), the US, Eurozone, UK and India (Thursday),

Canada also updates retail sales for August that are expected to rise by 0.5% m/m SA in accordance with Statcan’s advance estimate that is subject to revision. We’ll also get the first preliminary estimate for September to give us the whole quarter.

The US macro line-up will be light which will keep the focus on a heavy earnings season. Key highlights will be existing (Wednesday) and new home (Thursday) sales, durable goods orders (Friday) and whether a bigger hurricane effect shows up in Thursday’s initial claims.

Tokyo CPI will give markets the last core inflation reading before the BoJ’s October 31^st decision that is expected to be a hold.

LatAm markets face Mexico’s monthly GDP reading for August (Tuesday) plus retail sales (Wednesday), and Brazil’s inflation reading on Thursday.

European markets will only have Germany’s IFO business confidence (Friday) and the ECB’s 1- and 3-year inflation expectations (Friday) to consider. Russia’s central bank is expected to hike by another 100bps on Friday.