Markets and economists react: Bets for a BoC rate cut next week spike after soft GDP data

Money markets are placing significantly higher bets on a Bank of Canada rate cut next week following a softer-than-expected Canadian GDP report this morning as well as a market-friendly inflation reading in the U.S.

Implied probabilities in swap markets imply just over an 80% chance of a quarter-point rate cut at the June 5 Bank of Canada policy meeting, up from about 66% odds prior to the 830 a.m. ET data. Those odds were only at about 60% earlier this week. Bond yields immediately fell after the data, with the Canada five-year government bond yield declining about 10 basis points.

The Canadian economy expanded at an annualized rate of 1.7% in the first quarter and real gross domestic product likely rose 0.3% on a monthly basis in April, data showed on Friday. The quarterly growth rate was slower than the 2.2% pace forecast by analysts in a Reuters poll, as well as the Bank of Canada’s (BoC’s) 2.8% forecast. Fourth-quarter GDP growth was revised to an annualized rate of 0.1% from 1.0% reported initially.

The GDP report shows that Canada’s economy did not rebound from a soft patch last year as strongly as data initially suggested. Friday’s report is the last major data to be released ahead of the BoC’s interest rate announcement next week, when three-quarters of the 29 economists polled by Reuters this month expect a 25 basis-point cut.

Meanwhile, the U.S. released its Personal Consumption Expenditures Price Index at the same time, which suggested progress on taming inflation. Stock futures immediately turned green on the data.

The Personal Consumption Expenditures Price Index rose 0.3% in April, in line with forecasts by economists polled by Reuters. In the 12 months through March, PCE inflation gained 2.7%, as expected. Core PCE, which excludes the volatile food and energy components, increased 0.2% last month against expectations of a 0.3% increase. Annually, it was at 2.8%, in line with forecasts.

The following table details how swaps markets are pricing in further moves in the Bank of Canada overnight rate, according to LSEG data (formerly known as Refinitiv Eikon) minutes after the GDP figures were released. The current Bank of Canada overnight rate is 5 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.

And here’s how markets were pricing in monetary policy changes just prior to the data being released:

Here’s how economists are reacting to this morning’s GDP data in written commentaries:

Royce Mendes, managing director and head of macro strategy at Desjardins Securities

Once again the Canadian economy is coming up short. The 1.7% pace of growth in Q1 undershot consensus expectations for an increase of 2.2% and the Bank of Canada’s prediction of 2.8%. The miss, however, came from the volatile inventories category. As a result, final domestic demand, a better gauge of underlying momentum, still advanced a heady 2.9% in the first quarter. That’s obviously better news than in previous quarters, but is being aided by the growing population.

Households opened their wallets, with consumption rising 3.0%. In fact, Canadians spent more on a per capita basis in Q1 after three quarters of declines. Despite this spending, a strong increase in disposable incomes helped the household savings rate rise to 7.0%, the highest level since Q1 2022 and well-above the pre-COVID average. After two quarters of material declines, businesses were also back to investing in Canada, particularly firms in the oil and gas sector.

Revisions wiped out growth previously seen in Q4 2023. After originally saying the economy grew 1.0% in the final trimester of last year, StatCan now believes the economy posted a meagre 0.1% advance. That said, final domestic demand was actually revised higher from -0.7% to 0.0%. That’s still uninspiring, but is at odds with the downward revision to the headline which came largely as a result of weaker inventory accumulation.

The flash estimate for April GDP showed an advance of 0.3% after a flat reading for March. The rebound, however, is likely in part due to the resumption of activity in the auto manufacturing sector after retooling-related shutdowns in March. As a result, don’t expect the economy to maintain April’s growth rate through the rest of the second quarter. Our team is tracking growth of between 1.5% and 2.0% for Q2, in line with the Bank of Canada’s 1.5% forecast.

Although the headline numbers likely overstate the weakness in Canada’s economy, today’s data confirm that the Bank of Canada needs to cut rates next week. With inflation cooperating, we expect Canadian central bankers to begin a rate cutting cycle on June 5th. Markets are moving to price in more divergence between the Bank of Canada and the Fed after seeing these numbers, with yields down across the Government of Canada curve.

Douglas Porter, chief economist, BMO Capital Markets

Looking through all the monthly and quarterly wobbles, the big picture is that Canada’s economy has expanded by a meagre 0.5% in the past year. While the downside surprise in Q1 was driven by a big cut in business inventories, the reality is that underlying growth remains well short of potential, and slack is building for the overall economy. For the Bank of Canada, we believe the main message is that the output gap is widening, as reinforced by a less-tight job market, modestly increasing the chances of a rate cut next week. There are respectable arguments on both sides of the decision, but we believe the balance of evidence points to a cut—we’ve been calling for a June cut since late last year, and will stand by that call.

Olivia Cross, North America economist, Capital Economics

The 1.7% annualised gain in GDP in the first quarter was weaker than the Bank of Canada’s forecast for an above-potential 2.8% increase. With consumption growth looking much stronger than expected, however, we don’t think this enough to push the Bank of Canada to cut interest rates at its June meeting next week, rather than waiting until July.

Admittedly, growth in the fourth quarter was also revised sharply, from 1.0% annualised to just 0.1%. However, after all the revisions to previous data are accounted for, the level of GDP in the fourth quarter was a bit higher than before. Despite the downside surprise in the first quarter, the details look positive. Most of the miss was due to a drag from slower inventory building, which subtracted 2%-pts from GDP growth. Household consumption growth remained surprisingly strong given the weaker retail sales data, rising by 3.0% annualised in the first quarter, from an upwardly revised 3.2% in the fourth. We had expected government consumption to drive much of the growth in the first quarter, thanks to the end of the public sector workers’ strikes at the end of 2023. However, government consumption grew by a reasonably modest 2.1% annualised. Business investment rebounded by 3.1% annualised, which StatsCan noted was drive by increased investment in the oil & gas sector, presumably as producers geared up for the opening of the Trans Mountain Pipeline expansion.

The preliminary estimate of the monthly GDP data suggested that GDP rose by 0.3% m/m in April, which would put GDP on track to slightly outperform both our and the Bank of Canada’s forecasts for growth of 1.5% annualised in the second quarter.

Katherine Judge, economist with CIBC World Markets

The monthly GDP figures showed that momentum faded as the quarter progressed, with activity at the turn of the year supported by the end of strikes and milder than normal winter weather. The March GDP print showed no growth as expected, while April showed a rebound to 0.3%, which will include an increase from the resumption of activity at auto plants following retooling shutdowns. The Bank of Canada remains on track to cut interest rates in June given the cooling seen in inflation and the fading of momentum in GDP over the quarter.

More to come