Odds of Big Interest Cut Increases as September Inflation Falls to 1.6%

The odds of the Bank of Canada making an oversized, 50-basis-point interest rate cut when it meets next on October 23 are up after the country’s inflation rate fell to 1.6% in September. That represents the lowest inflation rate in three and a half years.

September’s inflationary reading of 1.6% was also down from 2.0% in August and is lower than Bay Street projections for inflation to fall to 1.9%. Canadian inflation is at its lowest rate since February 2021, when inflation was 1.1%. Canada’s current inflation rate is also well below the Bank of Canada’s 2.0% target.

The sharp drop in inflation, which is measured by the Consumer Price Index, was pushed lower largely by decreasing gasoline prices. If you take gasoline out of the equation, which can be a volatile measure, Canada’s inflation rate came in at 2.2%, unchanged from August.

Slower inflation does not mean everything is less expensive. Inflation is cooling but grocery prices in Canada have climbed faster than the inflation rate for two months in a row, with fresh and frozen beef costs up 9.2% on an annual basis. Food from stores costs 2.4% more than it did a year ago.

September’s inflation report is the last piece of major economic data to be released before the Bank of Canada meets again on October 23. The central bank has cut its key lending rate by 25 basis points (0.25%) for the last three consecutive meetings to 4.25%, a level last seen in December 2022.

Why Would The Bank of Canada Announce a 50-Basis Point Cut?

If you’ll recall, the Bank of Canada raised interest rates 10 times between March 2022 and June 2023 in an effort to tackle pandemic-fueled inflation and bring it down to its 2% target. In June 2022, Canada’s inflation rate stood at 8.1% and has since fallen to 1.6%.

While lower inflation is obviously welcome news for Canadians, chances are good that the Bank of Canada will have to announce a larger 50-basis point (0.50%) interest rate cut in late October.

Why? The Canadian economy is faltering, and lower interest rates make it cheaper to borrow which should encourage spending and heat up the Canadian economy.

September’s jobs numbers were better than expected, with the economy adding 47,000 jobs but the solid jobs numbers were more of an anomaly than representative of any real trend.

Canada’s gross domestic product (GDP) expanded by 2.1% in the second quarter but that was primarily a result of increased government spending on higher wages for public sector employees.

The fact is that Canada’s unemployment rate is still high at 6.5% and consumer and business sentiment remains weak. This, coupled with a bigger-than-expected cooling of inflation, opens the door for the Bank of Canada to make deeper interest rate cuts.

As of this writing, Bay Street is pricing in a 70% chance for a 50-basis point cut on October 23. The odds were just 50% before the September inflation data was released. That would take interest rates down to 3.75%. Bay Street is also pricing in a 50-basis point cut to interest rates in December, which would take interest rates down to 3.25% with smaller 25-basis point cuts in 2025.

The Bank of Canada’s goal is to get inflation down to a so-called “neutral” rate, this is, a spot where interest rates don’t restrict economic growth or cause greater growth.

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