Bank of Canada presses the accelerator on rate reductions… “to stick the landing”

Stephen Miller

In a move that markets had certainly contemplated, the Bank of Canada cut its policy rate by 50 basis points (bps) overnight to take the policy rate to 3.75 per cent.

That move followed a three successive 25 bp reductions at the previous three meetings.

Inflation looks to be comfortably within the target range with headline inflation at 1.6 per cent and trimmed-mean inflation at 2.4 per cent. Economic activity growth and the labour market are, however, languishing. In that context the accelerated rate of policy rate cuts did not come as a complete surprise.

Bank of Canada Governor Macklem described the measure as one designed while maintaining low and stable inflation. He added that the Bank now sees upward and downward risks to its inflation projection as “reasonably balanced.”

In that context the Bank cautioned that the “timing and pace” of future cuts will be based on incoming data.

Is the Bank of Canada experience a portent for the RBA? (Spoiler alert: not really)

While the Canadian experience is salutary one, there are enough differences between the Australian and Canadian (and New Zealand and Eurozone and UK) economic environments and central bank practice that caution against the drawing of too much by way of parallels.

Where the Reserve Bank of Australia (RBA) has differed from other developed country central banks, including the Bank of Canada, is that it has shown a reluctance to raise rates as far and as fast. 

For example, while the Bank of Canada policy rate is now at 3.75 per cent, it had raised the policy rate to 5 per cent by July 2023 and kept it there for almost 11 months. By contrast the RBA policy rate as at July 2023 was 4.1 per cent. It raised that to 4.35 per cent in November 2023 and has kept it there since.

The consequence of a relatively lower policy interest rate in Australia has been relatively better labour market outcomes. 

The recent labour force survey for September revealed an unemployment rate in Australia of 4.1 per cent. In Canada the unemployment rate is 6.6 per cent.

The downside has been relatively “stickier inflation”.

A reasonable forecast for annual Australian trimmed-mean inflation for the September quarter is around 3.5 per cent. In Canada the annual trimmed-mean CPI increased just 2.4 per cent. 

And what that suggests is that in Australia policy rate adjustments on the downside will lag those in other developed countries.  

This was implied in the RBA Governors’ press conference on 24 September and very much implied in the minutes of the RBA Board meeting held that day. 

Economic developments since the last meeting have by and large vindicated the RBA “experiment” of adopting a more cautious approach than its developed country peers in raising the policy rate. 

Such an “experiment” was aimed at mimimising any dislocation in the labour market. Last week’s strong labour market report affirms that objective is being met. 

But to reiterate, that comes at the cost of a more elongated return of inflation to target.

Nevertheless, the RBA Board acknowledges a risk that the ‘pickup [in household spending] is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market.’

There is, as yet no evidence of that ‘sharper deterioration in the labour market’.

Nevertheless, such a deterioration is a non-trivial risk and one to which the RBA would certainly respond.

In my view the RBA may soon be in a position to see some light at the end of the tunnel on inflation.

The recent NAB Monthly Business Survey showed revealed some “straws in the wind” that inflation has stepped down in a manner that will allow the RBA to more confidently judge that inflation is heading sustainably back to target in in line with the forecasts issued in August. (Having said that input costs, including labour costs are running significantly ahead of output prices, implying Australian businesses are under margin contraction pressure.)

If, as I suspect, labour market outcomes and inflation outcomes will be broadly in line with RBA forecasts, then the RBA might reasonably expect to cut rates in February.