CIBC says Bank of Canada interest rate moves clouded by neutral rate

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The Bank of Canada is being silent on what it will do about interest rates in the future, and that’s understandable given it’s not just the threat of tariffs that has policymakers feeling around for direction, many economists say.

“The Bank of Canada isn’t so sure about what comes next, but then again, who is?” Avery Shenfeld, chief economist at CIBC Economics, said in a note following Wednesday’s rate cut.

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Policymakers reduced interest rates for the sixth straight time, this time by another 25 basis points to three per cent, significantly down from five per cent in June, but still shy of the end rate in most economists’ opinions.

The Bank of Canada was mum on where it will go from here, which was a departure from recent practice.

“The cross currents on the economic outlook are clouded enough that the bank eschewed any clear message about its plans for future moves,” Shenfeld said.

The will-he-or-won’t-he tension around Donald Trump’s tariffs threats — described by Bank of Canada governor Tiff Macklem as a “major uncertainty” — is mostly to blame for the lack of clarity that Canadians crave on interest rates, but that’s not all at play, these economists say.

For example, there is the ongoing difficulty in pinning down the neutral rate, where the cost of borrowing neither stimulates nor depresses economic activity, which is key to figuring out how low rates need to go.

“The (Bank of Canada) faces some uncertainties over where the neutral rate lies and, therefore, how low rates need to be to achieve their projected pickup in economic activity,” Shenfeld said.

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Bank officials are forecasting for gross domestic product to come in at 1.8 per cent this year and next, up from 1.3 per cent in 2024, according the Monetary Policy Report, which came out on Wednesday.

Shenfeld thinks three per cent still restricts economic growth so that the Bank of Canada will need to cut by another 75 basis points. That would push its benchmark lending rate down to 2.25 per cent, the bottom of the central bank’s neutral range of 2.25 per cent to 3.25 per cent.

Shenfeld said a “soft” labour market and “tame” inflation make the case for more rate cuts, so he’s sticking with his rate forecast even if a trade war breaks out.

In the case of tariffs, “the need for even more aggressive rate cuts would also depend on the fiscal policy response,” he said.

Other economists agree that solving the neutral rate question is key to future Bank of Canada decisions.

“Overall, we believe that the general direction for interest rates is lower and that another cut at the March meeting is likely,” Charles St-Arnaud, chief economist at credit union Alberta Central, said in a note.

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He said slower population growth this year and next will hit the economy and likely drag down the neutral rate, so “at three per cent, the current policy rate level will become restrictive as population growth slows.”

Economist David Rosenberg, founder of Rosenberg Research & Associates Inc., said the Bank of Canada’s range for the neutral rate is flawed because it applies to “an economy in perfect equilibrium.”

But Canada’s economy is in a state of “excess supply,” according to the Bank of Canada governor, while the unemployment rate of 6.7 per cent is higher than the full employment rate of five per cent unemployment and inflation is below target in many sectors.

Interest rates should already be much lower, at two per cent or even as low as 1.5 per cent, based on one technical measure, Rosenberg said.

“The market is telling you that the (Bank of Canada) will do little more than bring the policy rate down to the midpoint of its own estimate of where the neutral range is, which makes no sense given that it continues to acknowledge that the economy is not in balance at all but is stuck in a deflationary state of excess supply,” he said in a note prior to Wednesday’s rate cut.

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If tariffs arrive, however, Rosenberg said the Bank of Canada could be forced to go to “zero-bound.”

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The Bank of Canada cut its interest rate by 25 basis points to three per cent on Wednesday, while warning that the economic consequences of a prolonged trade war with the United States could be severe, hindering growth while potentially reigniting inflation.

Bank of Canada governor Tiff Macklem noted that while inflation has held near the bank’s two per cent target since August and household spending is picking up, a trade conflict with the United States has clouded the economic and inflation outlooks. — Jordan Gowling, Financial Post

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WASHINGTON — The Federal Reserve left its benchmark interest rate unchanged Wednesday after cutting it three times in a row last year, a sign of a more cautious approach as the Fed seeks to gauge where inflation is headed and what policies President Donald Trump may pursue. — The Associated Press

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• Today’s Data: United States quarterly GDP, initial jobless claims and pending home sales. Canadian Federation of Independent Business releases its business barometer for January. Statistics Canada releases data on employment payroll for October.
• Earnings: Rogers Communications Inc., Canadian National Railway Co., Mastercard Inc., Apple Inc., Visa Inc., Intel Corp.