'Arguing for bigger rate cuts': What lagging GDP might mean to the Bank of Canada

Soft economy still making case for another 50 basis-point trim, some economists say

Gross domestic product data released on Thursday suggests Canada’s economy is going to be worse than the Bank of Canada expects.

An advance estimate from Statistics Canada forecasts September GDP rose 0.3 per cent month over month, while a flat reading for August coupled with a downgrade for July to 0.1 per cent from 0.2 per cent means the economy likely expanded at an annualized pace of one per cent in the third quarter.

That’s lower than the forecast the Bank of Canada made in its monetary policy report last week of 1.5 per cent, which was revised downward from its forecast of 2.8 per cent in July.

Here’s what economists think this means for the Bank of Canada and the next interest rate cut.

‘Downside’ risks: RBC

“We expect economic conditions will continue to look soft in the near term,” Claire Fan, an economist at Royal Bank of Canada, said in a note. “Rate cuts from the Bank of Canada impact the economy with a lag and the level of interest rates is still high.”

The Bank of Canada’s benchmark lending rate is now 3.75 per cent, down from a more than two-decade high of five per cent at the beginning of June.

Fan said there are “downside” risks to Statistics Canada’s flash estimate for September of a 0.3 per cent month-over-month increase in GDP, including elevated levels of trading in financial markets that supported growth in August and likely did so in September.

The agency’s flash estimate also suggested retail sales rose in September, but RBC’s proprietary card data indicated “weaker consumer spending” in September, Fan said.

Other advance indicators showed that manufacturing sales volumes fell in September, as did the number of hours worked.

RBC estimates the Canadian economy expanded at a quarterly annualized pace of one per cent in the third quarter.

“Soft GDP growth in Canada (is) still arguing for bigger rate cuts,” Fan said.

Sticking with a 25-bps cut: Desjardins

“Markets are interpreting the Q3 undershoot in GDP as a sign that the Bank of Canada needs to deliver another jumbo-sized rate reduction,” Royce Mendes, managing director and head of macro strategy at Desjardins Group, said in a note on the data.

But he thinks the GDP report hints at an economic rebound percolating in the Canadian economy given the gains in August in the insurance, financial services and “interest rate sensitive” retail sectors.

Mendes said the estimated GDP gain for September could be partly due to a rebound from the railway work stoppages this summer, but he estimates the three-month annualized GDP in September is clocking in around the two per cent range.

“Keep in mind that any pickup in underlying momentum during those three months came before the latest 50-basis-point rate cut,” he said.

Markets might be calling for another interest rate cut of 50 basis points, but Mendes thinks that signs of a reaccelerating economy might make the “forward-looking” central bank wary of another jumbo cut.

“So, at least for now, we’ll stick with our call that the Bank of Canada returns to a more standard 25-basis-point move in December,” he said.

Immigration cuts call for action: Capital Economics

“The Bank (of Canada) may take some comfort from September’s apparent healthier outturn of a 0.3 per cent month-over-month gain, which provides a strong handover to fourth-quarter growth,” Thomas Ryan, North America economist at Capital Economics Ltd., said in a note.

However, no growth in August and the July GDP downgrade mean third-quarter GDP will likely “sharply” undershoot the Bank of Canada’s estimate.

Ryan thinks policymakers will also be forced to move more quickly on rates after the federal government announced significant cuts to its immigration targets for 2025 and 2026.

Immigration has been cited by many economists as helping to prevent the Canadian economy from falling into a technical recession — two consecutive quarters of negative growth — though some have said it is in a downturn based on GDP per capita, which has contracted in eight of the past nine quarters.

“We judge that the Bank (of Canada) will need to bring interest rates to the neutral range more quickly than markets are currently pricing in,” Ryan said, calling for another 50-basis-point interest rate cut when central bank officials next meet on Dec. 11.

‘Trick and treat’: CIBC Capital Markets

“Canadian GDP was both trick and treat, with weakness at the start of Q3 followed by a solid rebound during its final month,” Andrew Grantham, an economist at CIBC Capital Markets, said in a note.

Despite the estimated uptick at the end of the quarter, he thinks there is more “slack” in the economy than the Bank of Canada has accounted for.

“Today’s figures suggest that the economy continued to grow at a pace below its long-run potential in Q3, which is consistent with the slight rise in unemployment rate seen during the quarter,” he said.

Canada’s unemployment rate currently stands at 6.5 per cent, just off the recent high of 6.6 per cent in August.

CIBC is calling for another interest rate cut of 50 basis points, but new jobs data and another GDP report in November will likely hold more sway with central bank officials and are “more important for that call than today’s data,” Grantham said.

• Email: gmvsuhanic@postmedia.com

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