Why markets expect the Bank of Canada to cut rates tomorrow

Kshatriya explains that this high probability of a cut brings Canada closer to what was expected somewhat earlier in the year. He says that Canada still has a roughly 50 per cent chance of slipping into a mild recession, in large part because the economy is more interest rate sensitive than its US counterpart.

If we do not get a cut tomorrow, Kshatriya expects that to come with a very dovish tone. He believes that if Macklem doesn’t drop rates by 25 basis points tomorrow, he will lay the groundwork for a cut at the July meeting. 

One factor that some say has kept Macklem from cutting earlier, or at least signalling a cut earlier, has been the housing market. Given the state of housing affordability and shelter inflation, there are concerns that a telegraphed cut may reintroduce speculation and froth into the Canadian housing market and drive prices up higher. Kshatriya accepts that concern, but notes that the core issue is one of supply, and the BoC has no control over that. Moreover, while a cut may increase real estate prices, it will also serve to lower some of the inflationary pressure around shelter costs.

One area that may give the BoC pause, however, is wage inflation. While the BoC’s goal of “further and sustained” easing seems to be on course across most major datapoints and metrics, wage inflation remains elevated. However, there has been a relatively large spike in unemployment over the past year or so, rising from 5 per cent in 2023 to 6.1 per cent in 2024. Kshatriya believes that should provide enough cover for Macklem to cut.

If Macklem chooses to hold, Kshatriya says that the market reaction will be determined in large part by the language that accompanies a hold. While any hold would be greeted as hawkish at this point, if the language really sets the stage for a July cut, the market reaction may not be so severe. If they cut, too, the language will be key. The BoC may do what Kshatriya calls a “hawkish easing” where they cut but signal that cuts will be far fewer and shallower than the market expects.