Markets signal a rate reduction is now more likely as tariffs continue weighing down the economy
The national economy regressed in the second quarter as trade tensions with the US continued to pummel the growth outlook, leading markets to increase their expectations of a September interest rate cut by the Bank of Canada.
Statistics Canada said on Friday morning that gross domestic product (GDP) slowed by 1.6% year over year in the second quarter, slightly more than the central bank had expected, as exports fell amid the ongoing trade war.
Markets priced in a 55% chance that the central bank would cut rates in its next decision, up from around 40% before the announcement, signalling that traders view a reduction as more likely – but still not a cert.
Strong consumer spending helped offset some of the damage caused by the trade war, jumping to an annualized pace of 4.5%, while residential investment was up 6% after plunging in the first quarter.
TD economist Rishi Sondhi said upcoming economic data will be pivotal in guiding the Bank’s decision.
“Domestic demand looks to have surprised on the upside. On the margin this could enhance the argument for the Bank to stand pat on rates at their September 17 meeting,” he wrote. “However, policymakers still have one more jobs and inflation report to digest before that time.
“The contraction in overall GDP also implies that slack built in the economy in Q2, and even with a better performance in Q3 likely on tap, the economy probably remains in excess supply. This points to further downward pressure on inflation and could pave the way for more rate cuts this year.”
Benjamin Reitzes, Bank of Montreal (BMO) managing director, Canadian rates and macro strategist, fixed income strategy, said the picture has changed little for the central bank despite the Q2 contraction.
“It should come as no surprise that the Canadian economy struggled in Q2 as tariffs ramped up,” he wrote. “However, the domestic strength is somewhat comforting, although the sustainability of that momentum is an open question.
“Arguably, the economy is evolving largely in line with the BoC’s July MPR forecast. Policymakers opted to stay on hold then, so this report likely doesn’t push them any closer to cutting in September, with the LFS [jobs report] and CPI [inflation report] still to come.”
But Canadian Imperial Bank of Commerce (CIBC) economist Andrew Grantham believes the Bank is still likely to cut rates in September.
“The main news in today’s release is actually how weak momentum still was towards the end of the quarter and into the start of Q3,” he said, “even as exports had begun to stabilize.
“We continue to think that a couple more interest rate cuts from the Bank of Canada are needed to accelerate the recovery, and assuming no fireworks in next week’s LFS figures, we forecast the first of those being delivered at the upcoming September meeting.”
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