Canadian Dollar: Bank of Canada Ready to Park Rates

Image © Bank of Canada

The Canadian Dollar rose after the Bank of Canada cut interest rates 50 basis points. Investors now think the end of the cycle is close.

The Bank of Canada reduced its base rate by 50 basis points for a second consecutive time, taking the base lending rate to 3.25%.

With the cut largely anticipated, the guidance regarding future rate cuts was always where market interest lay.

"Going forward, we will be evaluating the need for further reductions in the policy rate one decision at a time," said the Bank in a statement.

The rise in the Canadian Dollar and government bonds confirms this as a 'hawkish' steer (i.e., less inclined to ease policy), and the market thinks the 50bp cut won't be repeated.

"Bond yields moved higher as central bank dropped specific guidance on further rate cuts ahead, but remained well below where they stood prior to the recent jobs data. Similarly, the Canadian dollar recovered some ground," says Avery Shenfeld, an analyst at CIBC.

In fact, odds have increased that the Bank will leave rates unchanged at the next meeting.

"Having now entered the 'neutral zone' (estimated by the BoC to be 2.25% to 3.25%), there’s an apparent desire to dial back the pace of easing, which markets interpreted hawkishly," says Taylor Schleich, an analyst at National Bank of Canada.

This is an important development for the Canadian Dollar in a foreign exchange market that is highly sensitive to relative interest rate developments.

The Canadian Dollar has come under pressure in 2024 as the Bank of Canada proved to be the most eager to cut interest rates in response to a flagging economy and convincing disinflation.

CAD could be set to appreciate in value if the Bank steps back.

The Pound to Canadian Dollar (GBP/CAD) exchange rate dropped 0.45% in the 15-minute window following the decision, reaching 1.8018. The U.S. Dollar-Canadian Dollar (USD/CAD) fell a similar amount, reaching 1.4125. The Euro to Canadian Dollar (EUR/CAD) has retreated to 1.4825.

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"Growth is disappointing and excess supply in the economy is growing. This will justify further rate cuts ahead but at a slower pace in 2025, having already loosened policy by 175bp since June," says James Knightley, Chief International Economist at ING Bank.

ING thinks that the central bank will now move in smaller 25bp increments at quarterly intervals, targetting 2.75% by the second quarter of 2025.

"The Bank of Canada signalled that it's done with the big guns, but it likely still has bullets to fire as it eases rates with an eye to accelerating economic growth ahead," says Shenfeld. 

CIBC estimates Canada's neutral base rate sits at 2.75%, the midpoint of the Bank's estimated range.

But analysts think the Bank will need to cut below here to get the economy back on track, and think the rate will be taken to 2.25% on a series of quarter point cuts ahead.