Why 5 out 6 Banks see a Big Rate Cut

Most of Canada's biggest banks now believe that the central bank will lower interest rates by half a percentage point, after inflation fell more than expected last month. Only Toronto-Dominion Bank still sees a smaller chance of either a 25 or 50 basis-point cut in the coming week. This follows a recent report showing that inflation dropped below the Bank of Canada’s 2% target for the first time in over three years.

Several major banks, including Bank of Nova Scotia, Bank of Montreal, and National Bank of Canada, have now joined Royal Bank of Canada and Canadian Imperial Bank of Commerce in predicting a larger rate cut. Previously, they had forecast a smaller 25 basis-point cut for the upcoming October 23 decision. The shift in expectations signals that a slow and steady approach may no longer be enough to keep inflation from falling too far below the target as Canada’s economy weakens.

Many traders in overnight swaps are also betting that the Bank of Canada will cut rates faster than before, after reducing rates by 0.25 percentage points at the last three meetings. Right now, the benchmark interest rate sits at 4.25%.

Last month, Bank of Canada Governor Tiff Macklem said they could cut rates faster if inflation and economic growth slowed more than expected. This seems to be happening now. In the third quarter, inflation averaged just 2%—below the 2.3% the bank had predicted. Economic growth has also fallen short of forecasts. While the unemployment rate dropped to 6.5% in September, Canada’s job market has weakened as population growth has outpaced job creation.

Former deputy governor Paul Beaudry recently said that he wouldn’t be surprised by a larger rate cut in October, as conditions for quicker changes in monetary policy are already in place. Citigroup Inc. was one of the first to predict this, forecasting a 50 basis-point cut back in August.

Despite this, the Bank of Canada has been cautious about rushing to reduce borrowing costs. While inflation hit the 2% target in August, officials, including senior deputy governor Carolyn Rogers, have stressed that they need to see more progress on core inflation, which stood at 2.35% in September. The last time the Bank of Canada made a rate cut larger than 0.25 percentage points was during the pandemic, when the rate was slashed to 0.25% under then-Governor Stephen Poloz.

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