Canada’s economy showed surprising strength in the second quarter of this year, outpacing expectations with higher-than-anticipated growth. However, despite this strong showing, signs of economic weakness emerged during the summer months, raising the likelihood of an interest rate cut by the Bank of Canada (BoC) in the near future. As of now, financial markets are betting on an 80% chance that the BoC will lower interest rates by 25 basis points at its upcoming meeting on September 4th. There’s even a 20% chance of a more aggressive 50 basis point cut, a significant shift from just 24 hours ago when the likelihood of such a cut was considered minimal. Overall, the market is fully pricing in 75 basis points of cuts by the end of the year, remaining steady despite the recent GDP data.
The latest GDP figures reveal that the Canadian economy grew by 2.1% on an annualized basis in the second quarter. This was in line with preliminary estimates but exceeded both the consensus forecast of 1.7% and the BoC’s own projection of 1.5%. The growth was driven by government spending and a strong rebound in non-residential investment, particularly in machinery and equipment. However, household consumption growth slowed to just 0.6%, a worrying sign for the BoC. The real concern lies in the future. June’s GDP was revised down to show no growth, and preliminary data for July indicates a similar flat performance. Even if the economy rebounds in August and September, third-quarter growth is likely to fall short of the BoC’s 2.8% forecast, potentially coming in at less than 2.0%.
Given these factors, some economists are now considering the possibility of a 50-basis point cut this week, though the majority still expect a smaller 25 basis point reduction. The BoC’s next move will be critical, as it will signal how the central bank plans to navigate the delicate balance between fostering economic growth and managing inflation.
Experts from across the financial sector have weighed in on the situation:
Stephen Brown, Deputy Chief North America Economist: Brown notes that while second-quarter growth was stronger than expected, the slowdown in household consumption and the flat GDP readings for June and July point to a much weaker third quarter. He believes there is a nearly 50/50 chance of a 50-basis point cut next week.
Royce Mendes, Managing Director and Head of Macro Strategy at Desjardins Securities: Mendes argues that the BoC’s optimistic forecast for the third quarter now seems unlikely. He suggests that while a 25-basis point cut is the most likely scenario, a 50 basis point reduction could be on the table if the economy continues to underperform.
Derek Holt, Vice-President of Scotiabank Economics: Holt highlights the significant role government spending played in second-quarter growth, which he finds concerning given that it reflects retroactive wage increases rather than sustainable economic activity. He expects the BoC to proceed with a 25-basis point cut this week but warns of potential larger cuts in the future.
Douglas Porter, Chief Economist at BMO Capital Markets: Porter sees the strong headline GDP growth as misleading, noting that much of the growth was driven by government spending, with little contribution from the private sector. He expects the BoC to maintain its course with a 25 basis point cut, but acknowledges that weaker third-quarter growth could prompt more aggressive action later in the year.
As the BoC prepares to make its next move, the focus will be on how to support the Canadian economy amid these mixed signals. While the second quarter showed resilience, the outlook for the rest of the year remains uncertain, and the central bank’s response will be crucial in steering the economy through these turbulent times. The strong showing of the economy, lots of job growth in Ontario, and the slaying of inflation are all good signs of the beginning of a series of rate cuts by the Bank of Canada.