The Bank of Canada decided to cut rates by 25 basis points due to a perceived change in risk balance. The inflation rate remains mostly unchanged, although earlier this year, core inflation showed upward momentum, which has now decreased. Inflation signals are mixed, yet inflationary pressures appear more contained.
A weakening economy is expected to further suppress inflation. Tariffs adversely impact the Canadian economy, particularly visible in certain sectors. The bank will monitor exports and business adaptation to higher costs, with attention to risk balance in October. Some counter-tariffs, particularly in food, have been rescinded. Economic performance forecasts suggest a growth rate of around 1% for the second half of the year, indicating no recession expectation.
Market Expectations and Projections
Market expectations for an additional October rate cut have shifted to 42% from a previous 52% before the Bank of Canada’s decision. Projections for next summer slightly altered, with 29 basis points anticipated compared to 30 before the decision. Currently, no changes to the deposit rate are being considered. Various policy tools remain available for adjustments ahead of any deposit rate changes.
The Bank of Canada has officially pivoted, starting a cutting cycle based on a weakening economy. This shift in the balance of risks is a clear signal, especially with their forecast for growth at a sluggish 1% for the second half of the year. This aligns with recent data from Statistics Canada, which showed the economy barely grew in the second quarter, confirming the soft patch we are in.
While the market has lowered the odds of a cut in October, we see this as a potential opportunity. The underlying message is that inflationary pressures are contained and the economy needs support, meaning the path of least resistance for rates is down. We should consider positioning for this by receiving fixed on interest rate swaps dated for early 2026, as the market may be underpricing the total number of cuts required.
The Bank’s dovish stance is supported by the inflation picture, which has seen its upward momentum from earlier in the year fade. This view is credible when looking at the latest CPI report for August, which showed headline inflation cooling to 2.8%, well within a manageable range. This gives us confidence that the Bank has the flexibility to prioritize growth over inflation in its upcoming decisions.
Divergence with US Policy and Currency Impact
This creates a clear divergence with policy in the United States, which is a strong signal for the Canadian dollar. With the Federal Reserve still signalling a higher-for-longer stance, the widening rate differential should put downward pressure on the CAD. The mention of tariffs hurting Canadian exports, a situation reminiscent of the trade disputes from 2023, only adds to our bearish outlook on the currency.
Given the uncertainty around the timing of the next cut, options strategies are particularly relevant. The Bank’s statement that it is “not being as forward-looking as normal” suggests it will be highly reactive to incoming data before its October meeting. This environment is ideal for buying calls on CORRA futures to position for a potential surprise cut if the next jobs or GDP report disappoints.
