‘A watershed moment’: How market bets and economist views for future BoC rate cuts have shifted after September’s inflation data

Money markets are back to giving much higher odds to a large 50 basis points rate cut by the Bank of Canada at its next policy meeting next week following the softer-than-expected headline inflation reading this morning. Many economists are also now expecting a half percentage point cut.
Implied probabilities in overnight swaps markets, which capture market bets on where monetary policy is heading, are now giving close to 70 per cent odds of a 50 basis point cut on Oct. 23. The odds of a smaller 25 basis point cut are at about 30 per cent. Prior to this morning’s inflation report, markets were putting 50/50 odds on whether it will be a larger or smaller cut.
Markets are now fully pricing in a total of 75 basis points worth of monetary easing by the end of this year.
Canada’s annual inflation rate slowed more than expected to 1.6 per cent in September, mainly on cheaper gasoline, but indicators of underlying price pressures held steady, Statistics Canada said on Tuesday. Analysts polled by Reuters had forecast the inflation rate would cool to 1.8 per cent from 2.0 per cent in August. Month-over-month, the consumer price index decreased 0.4 per cent, compared with a forecast of 0.2 per cent decline.
The Canadian two-year bond yield fell five basis points on the data, to 3.018%.
Live updates: Canada’s inflation rate hit 1.6% in September
It’s the last major economic report to be released ahead of the Bank of Canada’s interest rate announcement on Oct. 23.
Here’s how implied probabilities of future interest rate moves stood in swaps markets just after the 830 am ET inflation data release, according to LSEG data. The overnight rate now resides at 4.25 per cent. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing. Columns to the right are percentage probabilities of future rate moves. The second table to the bottom is a breakdown of probabilities for the size of a cut on Oct. 23.
And here’s how the probabilities looked right before the inflation data release:
Here’s how economists and market strategists are reacting in written commentaries:
Douglas Porter, chief economist with BMO Capital Markets
Sliding energy prices were the big driver here, as core price inflation was largely as expected and essentially stable. Still, the long-awaited drop in headline CPI to below 2% is a watershed moment, which will help calm down inflation expectations. While gasoline will likely pop back up in next month’s report, some of the hottest components of shelter costs are relenting and will act as an undertow on overall inflation in coming months. It’s a close call, but we suspect that the big improvement in inflation, the still-high unemployment rate, and the still-sour consumer and business sentiment will be enough to prompt the Bank of Canada to opt for a 50 bp rate cut later this month. After all, the BoC has dovishly signalled that they are now more concerned about downside risks to the economy and the possibility that inflation may drop too low.
Claire Fan, economist, Royal Bank of Canada
On the cusp of the next BoC interest rate decision on October 23, the latest CPI report showed inflation pressures continuing to slow in Canada as expected in September. The drop in headline CPI reading may have been driven lower by lower gasoline prices but slower growth in the slew of Bank of Canada’s core inflation measures also pointed to progress. To be sure, shelter costs were still growing at a faster rate comparing to the rest of the consumer basket. But the scope of price pressure outside of shelter has now normalized more fully to what it looked like before the pandemic. Taken together with the third quarter release of the BOS survey last Friday that pointed to further unwinding in inflation pressures in the future, we think there’s little reason for the BoC to turn their worries back from a weakening economy to inflation, and expect them to go ahead with cutting by 50 bps next week.
Derek Holt, vice-president, Scotiabank Economics
There has been a lot of baseless on– and off-speculation around the Bank of Canada’s next move but it needed data to justify a call. We now have that. The Bank of Canada is likely to cut 50bps next Wednesday on the heels of a report that shows that the Bank’s preferred core measures are on target. That was our instant reaction with our traders and clients seconds after seeing the core gauges. There is still the risk that the BoC—that has surprised markets many times in the past—could opt for –25bps, but the hurdle to doing so is set rather high now. I’ll also argue that while it’s our call, we disagree with upsizing.
Key is that the average of the trimmed mean and weighted median measures of core inflation slowed to an average of 2% m/m SAAR [seasonally adjusted annual rate] in September. Weighted median CPI was the higher of the two at 2.3% m/m SAAR but trimmed mean CPI at 1.7% balances that out and the BoC tends to take an average. Traditional core (ex-food and energy) was up 2.4% m/m SAAR but this is on the heels of just 0.8% the prior month.
On a three-month moving average basis, traditional core CPI (ex-food and energy) is up by just 1.6% m/m SAAR, and both the weighted median and trimmed mean CPI gauges are up 2.1%. …
The BoC has surprised markets in the past, but it would need strong arguments to negatively surprise markets priced by 50. They would also need steely resolve to go against markets, most economists, and heavy pressure from the business community and politicians. Macklem is unlikely to be that person who goes against such pressure given his naturally dovish instincts and so the BoC’s reaction function has to get a high weight in the forecast call. …
Opting to cut 50bps and the aggressive market easing around the expected path forward are likely to ignite growth faster over 2025–26 than otherwise, closing the output gap quicker than estimated along ongoing other sources of inflation risk from real wage gains alongside terrible productivity, severe housing shortages and ongoing immigration, likely fiscal pump-priming into an election year, and our work on the pent-up demand and pent-up savings that exist in the household sector. The BoC is at significant risk of unleashing inflationary forces.
David Rosenberg, founder of Rosenberg Research
At 4.25%, the BoC rate is still around 150-200 basis points north of neutral and, given where inflation and the unemployment are, the BoC is well behind the curve, and there should really be nothing to stand in the way of a 50 basis point rate cut at the October 23rd meeting, even with the Fed having turned a tad less dovish of late. Good news for the front-end and mid-part of the GoC bond curve but less so for the Canadian dollar outlook.
On a seasonally-adjusted basis, consumer prices were flat, in the weakest reading since the turn of the year and that followed a sub +0.1% print in August. We have not seen one month so far this year in which the MoM increase was above +0.25%. …
Arguably the most reliable measure of underlying inflation is the CPIX, which excludes the 8 most volatile components and indirect taxes — it showed a faint pulse at +0.1% on a MoM basis and the YoY pace is benign to say the least at +1.6% (from +2.8% a year ago). In this sense, the BoC has not really eased at all this past year — the -75 basis points of cuts the last three meetings falls well short of the -120 basis point decline in this critical measure of core inflation, which means that the Bank surreptitiously has actually engaged in back-door policy tightening of +45 basis points even as Tiff Macklem has been acknowledging for the past six-plus months that the domestic economy has moved into a prolonged state of excess supply.
Shelter costs are off the boil, thankfully, but are still acting as a primary source of whatever inflation there is left in the system — up +5% year-over-year. And the principal driver remains mortgage interest rates — expenses here are up +17% from year-ago levels. Strip out shelter, and Canadian inflation is running at a microscopic +0.4% YoY pace (from +2.9% this time last year). The pre-COVID-19 norm was over +2%. Some may laugh looking at the data without sky-high rents and homeowner insurance, but the fact that Canadian inflation is now all the way down to +1% once the ridiculous inclusion of mortgage costs are adjusted for is not a laughing matter — unless you are long Canadian government bonds. To show how the other 94% chunk of the CPI has moved over the past year, the ex-mortgage interest inflation rate this time last year was pressing against +3%.
Indeed, pockets of outright deflation are emerging. Clothing prices, for example, are down -4.4% year-over-year. Telecom prices have deflated -5.1%. Furniture is basically flat and appliances are down -1.0%. Motor vehicles? Try -1.3%. Air fares have been sliced -4.4%. Once-hot recreation goods and services have cooled to a -0.4% YoY deflation rate. The list goes on, but there is only so much time in the day.
Royce Mendes, managing director and head of macro strategy, Desjardins Securities
With the share of components growing faster than 3% per year at just 30%, breadth indicators continue to suggest weakness across a range of categories. And that’s despite the fact that shelter inflation continues to run at an annual pace of 5.0%.
Core inflation measures didn’t move on a year-over-year basis, but three-month annualized rates slowed. The Bank of Canada’s core median and trimmed mean indicators averaged 2.35% for the second consecutive month. That said, the three-month annualized rates decelerated to 2.11% from 2.31% in August. Moreover, the three-month annualized rate of core services excluding shelter cooled to just 1.91% from 2.26%. These readings suggest weakness in recent trends and confirm that inflation is now at risk of falling below the Bank of Canada’s target.
Headline inflation is likely to bounce higher next month, but could still remain below 2.0%. Given the weakness in the economy, it’s clear that our 50 basis point rate cut call will become the consensus. The Bank of Canada needs to do something to revive the economy and stop inflation from falling too far. Our view is that a 50 basis point rate cut is the right dose of medicine.
James Orlando, director and senior economist, TD Economics
Encouragingly, inflation in services has started to ease (4.0% y/y from 4.3% y/y in August). Shelter costs have been a big driver of services inflation, but with lower interest rates, mortgage interest cost inflation has decelerated (16.7% y/y from 18.8% y/y in August), while rent prices too are easing (8.2% y/y from 8.9% y/y in August). Another swing factor over the last few months has been the cost of air travel. With the end of the summer travel season, this category is starting to drop (-4.4% y/y). …
With headline inflation now decisively below the Bank of Canada’s (BoC’s) target and core inflation looking likely to follow, inflation risks have eroded over the last few months. Below the surface, this trend looks to continue with housing costs finally starting to subside, with inflation excluding shelter running at a paltry 0.4% y/y. All in, the inflation outlook is looking a bit softer than we expected in our recently published forecast.
The BoC is scheduled to meet next week and debate over whether the central bank will go big with a 50 basis point cut is rising. Thus far, the bank has been predictable, with a steady streak of 25 bp cuts over the last three meetings. Given the persistent strength of the jobs market, the BoC would be validated in maintaining its steady rate cutting pace. On the other side, market participants are increasingly betting on a 50 bp cut, assuming that the BoC will focus on the downside risks now that headline inflation has moved closer to the bottom end of its target range. Either way, it will be a close call for the BoC next week.
Stephen Brown, deputy chief North America economist, Capital Economics
The large downside surprise to headline inflation in September and muted monthly gains in the CPI-trim and CPI-median core measures support our view that the Bank of Canada will choose a more aggressive 50bp cut at its meeting next week.
The fall in headline inflation to 1.6% left it below the consensus estimate of 1.8% and our own forecast of 1.7%. The fall in inflation owed a lot to the 7.1% m/m drop in gasoline prices and favourable base effects, but there were also encouraging disinflationary signs elsewhere that explain the downside surprise, with shelter prices rising by just 0.1% m/m in seasonally adjusted terms, the smallest gain in almost two years. That appears to have been due to weaker rent growth, perhaps related to the cap on international student numbers at the start of the academic year. Moves elsewhere were similarly muted, with food prices rising by 0.2% m/m, household operations, furnishing & equipment prices by 0.1% and recreation, education & reading prices by 0.1%, while clothing prices fell again.
The CPI-trim and CPI-median measures excluded some of the largest price declines last month, but still rose by a target-consistent 0.17% m/m on average, pulling the average three-month annualised rate down to 2.1%. While the annual rates were each unchanged, at 2.3% for CPI-median and 2.4% for CPI-trim, that was still a better result than the Bank expected. CPI-trim and CPI-median averaged 2.4% in the third quarter and headline inflation averaged 2.0%, both lower than the Bank’s respective forecasts, of 2.5% and 2.3%. With the activity data also pointing to much weaker third-quarter GDP growth than the Bank anticipated, the totality of the data should be enough to persuade the Bank to cut by a larger 50bp next week.
Matthieu Arseneau, deputy chief economist with National Bank Financial
September’s inflation data confirms once again that Canada’s generalized inflation problem has been solved. … Real policy rate in October was the tightest since 2007 when using CPI ex mortgage interest rate costs. With widespread inflation a thing of the past in Canada, and inflation expectations having continued to improve in the light of consumer and business surveys published by the BoC last Friday, we believe that the door is wide open for the Bank of Canada to bring its policy rate back to neutral (between 2.5% and 3.0%) as quickly as possible, by making deeper rate cuts than in the past. Job gains in September were not enough to stabilize the employment rate, and surveys do not point to any improvement in the medium term. The Canadian economy needs oxygen from the central bank to stabilize.
Charles St-Arnaud, chief economist, Alberta Central (credit union)
Overall, the Bank of Canada will welcome today’s report as it confirms that inflation continues to ease. Moreover, the breadth of inflationary pressures and the momentum of core inflation suggest a lack of underlying inflationary pressures. As we wrote earlier this month, we believe the BoC should accelerate the return to a more neutral monetary policy, especially considering the lacklustre economy and the lack of inflationary pressures. Doing so would allow the BoC to buy some insurance against an economic downturn. With this in mind, we think the BoC will cut its policy rate by 50bp at the October meeting, by another 50bp at the December meeting and by 25bp in January. This would bring the policy rate to 3.00%, about the upper range of the BoC’s estimate of neutral.
Lesley Marks, chief investment officer at Mackenzie Investments
The market had been oscillating between a 25 bp and 50 bp cut for the BoC and today’s inflation data likely offsets the strength in the employment number we observed in the September data, tipping the scales in favour of a 50 bp cut at the next meeting.
Although some may point to the stickiness of the core CPI number or the weakness in gasoline prices as the driving force behind weaker headline CPI, inflation appears to be less of an issue for the BoC than the prospect of a weakening economy. Central bankers will be mindful of the slowing economic indicators including the narrative from the third quarter Business Outlook Survey where businesses indicated that they are showing a weakening appetite to invest or add to headcount with high interest rates still being at the top of the list of reasons for a deteriorating outlook.
Tu Nguyen, economist from accounting and consultancy firm RSM Canada
It’s clear that the Bank of Canada is well behind the curve when it comes to rate cuts given that inflation has returned to target and growth has been sluggish this year. While the Bank has favoured the slow and gradual path, the data might convince them to speed up as the main concern has shifted from price stability to jobs and growth.
While the drop is driven by lower gasoline prices, inflation excluding gasoline dropped to 2.2%, well within the 1-2% preferred range and very close to 2%.
It’s important to understand that although the rate of price increases have moderated, price levels are permanently higher and not going back down.
Bryan Yu, chief economist, Central 1 (credit union)
With the latest data, inflation came in a touch above 2.0 per cent during the third quarter which was below the Bank of Canada’s forecast (2.3 per cent), while the average of the core measures also came in below its expectation. While the labour market showed some resilience in September, labour market slack persists, and wage growth decelerated. Coupled with the further drag on inflation as lower interest rates feed through mortgage rates and downside concerns to inflation, we anticipate a 50- basis point cut later this month and a 3.5 per cent year end rate.