This morning, the Bank of Canada (BoC) issued its third consecutive 0.25% rate cut, reducing the policy rate from 4.50% to 4.25%. This decision comes as the BoC continues its effort to combat economic slowdown, with variable mortgage rates immediately dropping by the same margin.However, while this move may offer temporary relief to borrowers, it opens up a broader debate on the long-term impacts of these cuts on the economy, especially in light of conflicting views among economists regarding the next steps for the BoC and the potential for a recession.
Fixed-rate mortgages, which are tied to Government of Canada bond yields, had already begun to decline in anticipation of the BoC’s move. Following the rate cut, Canadian and U.S. 5-year yields are trading 6 to 9 bps lower, respectively, after the BoC's announcement.​​​ Lower bond yields, if sustained, will lead to lower fixed rate offerings in the near term.
There had been speculation among analysts that the BoC might take a more aggressive stance and implement a 0.50% rate cut instead of 0.25%. While such a move would have contradicted recent statements from BoC Governor Tiff Macklem about gradual reductions, there were reasons to believe it could have been a viable option. However, the central bank opted for a more conservative approach, though some now wonder if it may regret not acting more decisively.
Many economists, like Derek Holt and Fan Liu, have argued that the BoC should continue with a slow and steady approach to rate cuts, carefully monitoring the economy’s reaction to each adjustment. They argue that sharp and aggressive cuts risk triggering a resurgence of inflation, potentially destabilizing the economy further.
But economist David Rosenberg offers a different perspective. He believes that the economic signals suggest the need for more aggressive cuts now, not later. Rosenberg has highlighted several recession indicators—such as yield curve inversion and the Sahm rule—pointing to a growing risk of economic contraction.Â
.According to Rosenberg, “45% of the recession indicators we tracked have been triggered, and since 1999, that’s never happened without a recession occurring.” While some argue that this timeline is insufficient to predict the future, the signs of a slowdown are undeniable: rising unemployment, negative job growth, slowing wage increases, and a drop in job openings.
Rosenberg’s analysis suggests that a slower, more measured approach may actually increase the chances of a deeper recession. By waiting too long to act aggressively, the BoC could find itself facing more severe economic damage down the road.
A key reason for the BoC’s cautious stance is the complex and mixed economic data it faces:
With memories of the inflation roller coaster of 2021-2023 still fresh, many Canadians fear the possibility of re-inflation, where rate cuts today might be followed by future rate hikes. For families living on tight budgets, such a scenario would feel like a sucker punch, especially for those who opted for variable mortgage rates in anticipation of long-term reductions.
Fortunately, Governor Macklem and the BoC have signaled that their primary concern is disinflation rather than the risk of re-inflation. With an excess supply in the economy, as Macklem himself put it, the Bank is more focused on preventing inflation from falling too fast and causing even more job losses.
According to David Rosenberg, the economic indicators clearly point to the possibility of a recession if the BoC continues its cautious approach. Rosenberg’s recession metric shows that 45% of the indicators that have historically preceded a recession are now triggered. These include unemployment climbing by 150 basis points, negative job growth in three of the last five months, and slowing wage growth. Additionally, job openings are disappearing at a concerning rate.
Given the current economic backdrop, many homeowners and prospective buyers are evaluating their mortgage options. While some may be drawn to the stability of fixed-rate mortgages, the case for variable rates remains compelling. Based on the expectation that the BoC will reduce its policy rate by another 1.5% to 2.0% over the next twelve months, today’s variable mortgage rates are likely to outperform fixed-rate options, even if variable-rate borrowers initially face higher rates.
That said, the future remains uncertain, and unforeseen events could lead to a different outcome. Homeowners should stay informed and flexible in their financial planning, balancing short-term opportunities with long-term stability.
While economists like Derek Holt and Fan Liu advocate for a cautious approach, the insights from David Rosenberg highlight the need for more decisive action to prevent the economy from sliding into a deeper recession. The BoC’s decisions in the coming months will be critical in shaping the financial future of Canadians.
After today's 0.25% rate cut, the below chart shows the expected BoC policy path over the next 5 years
Fixed-Rate Mortgages and Market Response
The Possibility of a Larger Rate Cut: What Could Have Happened?
Econonomist David Rosenberg vs. the Slow and Steady Approach
Many economists, like Derek Holt and Fan Liu, have argued that the BoC should continue with a slow and steady approach to rate cuts, carefully monitoring the economy’s reaction to each adjustment. They argue that sharp and aggressive cuts risk triggering a resurgence of inflation, potentially destabilizing the economy further.
But economist David Rosenberg offers a different perspective. He believes that the economic signals suggest the need for more aggressive cuts now, not later. Rosenberg has highlighted several recession indicators—such as yield curve inversion and the Sahm rule—pointing to a growing risk of economic contraction.Â
.According to Rosenberg, “45% of the recession indicators we tracked have been triggered, and since 1999, that’s never happened without a recession occurring.” While some argue that this timeline is insufficient to predict the future, the signs of a slowdown are undeniable: rising unemployment, negative job growth, slowing wage increases, and a drop in job openings.
Rosenberg’s analysis suggests that a slower, more measured approach may actually increase the chances of a deeper recession. By waiting too long to act aggressively, the BoC could find itself facing more severe economic damage down the road.
Economic Indicators Driving the BoC’s Decisions
A key reason for the BoC’s cautious stance is the complex and mixed economic data it faces:
- Inflation: In July, the Consumer Price Index (CPI) rose by 2.5% year-over-year, with mortgage interest costs accounting for 1.2% of that increase. Given the direct link between the BoC’s policy rate and mortgage interest costs, further rate cuts would likely help bring inflation down to its 2% target faster.
- GDP Growth: Canada’s GDP grew by 2.1% in Q2 on a quarter-over-quarter basis, exceeding expectations. However, on a per capita basis, GDP fell by 0.1%, meaning that individual Canadians are feeling the pressure of a slower economy. Much of the growth was driven by government spending, which surged by 6.7% quarter-over-quarter.
- Employment: The Canadian economy shed jobs in both June and July, with most job creation over the past year coming from the public sector. This reliance on government spending to drive employment growth is unsustainable in the long term.
- Wage Growth: Wage growth remains above 5%, but it is expected to slow significantly as base effects take hold. By the end of the year, wage growth could fall to 2%, which would ease inflationary pressures but could further weaken consumer spending.
- Consumer Confidence: Consumer spending has already slowed, debt levels are rising, and both consumers and businesses have reported reduced confidence in future economic prospects, as noted in recent BoC surveys.
The Threat of Re-Inflation: A Lingering Fear for Canadians
Fortunately, Governor Macklem and the BoC have signaled that their primary concern is disinflation rather than the risk of re-inflation. With an excess supply in the economy, as Macklem himself put it, the Bank is more focused on preventing inflation from falling too fast and causing even more job losses.
Recession Risk and the Potential for Larger Cuts
If these trends continue, the BoC may have no choice but to implement more aggressive rate cuts, possibly as much as 0.50% in upcoming meetings. Bond yields, already anticipating rate reductions, could fall even further, pricing in the possibility of a sharp downturn in economic activity.
Mortgage Selection Advice in an Uncertain Economy
That said, the future remains uncertain, and unforeseen events could lead to a different outcome. Homeowners should stay informed and flexible in their financial planning, balancing short-term opportunities with long-term stability.
While economists like Derek Holt and Fan Liu advocate for a cautious approach, the insights from David Rosenberg highlight the need for more decisive action to prevent the economy from sliding into a deeper recession. The BoC’s decisions in the coming months will be critical in shaping the financial future of Canadians.
After today's 0.25% rate cut, the below chart shows the expected BoC policy path over the next 5 years