David Rosenberg: The Bank of Canada has now offset the policy mistake it made a year ago. But there’s a lot more rate cutting that needs to be done

The Bank of Canada did the expected (and the right thing) on Wednesday by trimming the policy rate for the second meeting in a row, to 4.5 per cent from 4.75 per cent. More relief will be coming.
Yet again, the central bank stressed that the economy is operating with excess slack.
The bank sees real GDP growth of 1.2 per cent this year, which is roughly 100 basis points below the economy’s long-term potential. The projection of a 2.1-per-cent pickup in 2025 and 2.4 per cent in 2026 must imply in the forecast that rates are coming down much further because there is no such reacceleration absent more policy stimulus. (A basis point is one-100th of a percentage point.)
Even then, the Bank of Canada acknowledges that this growth pickup will only “gradually absorb excess supply through 2025 and 2026.”
So, while its press statement mentioned that shelter and select service-sector inflation remains stubbornly high, there is nothing in theory or practice that posits higher inflation in an economy running with spare capacity.
When you model out where the overnight rate should be in such a period of economic slack, it should be closer to 2 per cent than the current 4.5 per cent. Even under an economy in perfect balance with no excess supply, the neutral rate is an appropriate benchmark and that resides at 2.75 per cent. So there is no question that the Bank of Canada has a long row to hoe.
We have a situation where the CPIX inflation rate (that eliminates the noise from the eight most volatile components) is at 1.9 per cent, just about where it was in early 2020 before the pandemic hit. Strip out the mortgage interest nonsense, which is not a price anyone really pays at the shopping mall, and inflation is also running at 1.9 per cent. The unemployment rate, at 6.4 per cent, is almost a full percentage point above where it was in early 2020 and up 160 basis points from the cycle low – a Sahm Rule recession has already been triggered. The job vacancy rate, at 3.2 per cent, also is pretty well back to where it was before COVID.
Where was the Bank of Canada policy rate back then – keeping in mind that there was no excess supply in early 2020? Try 1.75 per cent. So when I say the bank has a long row to hoe … it is a very long row, indeed.
While the bank is telling us that policy decisions will be made meeting by meeting, it let the cat out of the bag with this little ditty: The breadth of price increases across components of the Consumer Price Index “is now near its historical norm.”
Well, guess what the historical norm is for the overnight rate? Try 1.6 per cent, which is the norm of the past 10 years.
In the accompanying opening statement to the Monetary Policy Report’s press conference, Governor Tiff Macklem served this up for us to chew on: “If inflation continues to ease broadly in line with our forecast, it is reasonable to expect further cuts in our policy interest rate. With the target in sight and more excess supply in the economy, the downside risks are taking on increased weight in our monetary policy deliberations.”
The central bank could not be clearer that a definitive easing bias is in place. In other words, this was an unmistakable dovish cut.
When you think about it, all the Bank of Canada has done with these two successive rate cuts is offset the policy mistake it made a year ago when it raised the rate 50 basis points just as the economy entered the excess supply environment that the central bank is currently emphasizing. The bank really should have begun cutting rates last April when it first uttered those excess supply words in its press statement – but apparently concerns over the early-year uptick in U.S. inflation held Mr. Macklem and Co. at bay.
There are two developments worth considering as to why the bank is justified in cutting rates with the U.S. Federal Reserve dragging its heels.
For one, there is no fiscal stimulus in Canada, but there is still a ton of it lingering stateside. Second, there are no 30-year fixed-rate mortgages in Canada – the economy here resets to higher interest rates much faster than is the case in the United States.
There was nothing like the US$2-trillion stimulus cheques handed out in 2021, as was the case under Bidenomics – a gift that has kept on giving to the U.S. Energizer bunny consumer. And the proof of the pudding is in the eating, with the year-over-year trend in Canadian real GDP running at 1 per cent compared with nearly 3 per cent south of the border.
In contrast to the Bank of Canada, the Fed would undoubtedly not be characterizing the U.S. economy as being in excess supply. That is an enormous difference that justifies the Canadian central bank’s go-it-alone stance. But don’t worry – the Fed will be following this global trend toward policy rate cuts in September, once chair Jerome Powell sets the table the month before at the Jackson Hole Symposium.
Canadian household debt relative to disposable income is off the peak, but at 163 per cent it is far higher than the United States’s 93 per cent. It is more than 30 percentage points above where the U.S. was in the mid-late 2000s, which was the biggest credit bubble in American history. Ergo, fully 15 per cent of after-tax income in Canada is now being siphoned into servicing the massive debt load (where it has been in the past just ahead of recessions), compared to less than 10 per cent in the U.S.
Tack on that Canada is in excess supply well ahead of the U.S., that the fiscal deficit ratio is one-quarter the size north of the border, that year-over-year real GDP growth, at 1 per cent, is fully two percentage points below the U.S. trend, and that all measures of core inflation are already in the Bank of Canada’s target zone, and the case for further easing is strong. Don’t be surprised if we see the policy rate spread with the U.S. become as negative as 200 basis points and the Canadian dollar breaking below 70 US cents in the months ahead.
Bottom line: The Bank of Canada is hardly done – this is the early stage of what will prove to be more than just a partial unwind of the most severe tightening cycle since the John Crow era of the late 1980s. Bullish for the front and mid-part of the government of Canada curve and bearish for the Canadian dollar because the local economy is in a far weaker state than is the case south of the border, and Canada’s central bank is simply going to have to do far more than the Fed.
David Rosenberg is founder of Rosenberg Research
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