That should do it

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   By Guest Blogger Ryan Lewenza

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For months we’ve been talking about peak interest rates with the Bank of Canada (BoC) set to reverse course and begin to cut rates. Well, with this week’s better-than-expected inflation report the BoC has what it needs to justify a cut, potentially as early as June. If correct, just think of the positive implications for the economy and markets in the coming months.

Inflation eased again in February coming in at 2.8% y/y, below what the economists were calling for (3.1%). This marks the third straight month of slowing inflation and continues the longer trend of lower inflation since the peak of 8.1%  back in the summer of 2022. This is great news and shows rate hikes are working.

Canadian CPI fell to 2.8% y/y in February

Source: Bloomberg, Turner Investments

Interestingly, industries getting a lot of negative attention from the Canadian government – telecom and grocery stores – are finally starting to see an easing in pricing pressures with telecom prices actually declining. Yes you heard that correct.

According to Statistics Canada, cellular service prices are down 26% from last year (I need to check my recent bills because that doesn’t sound right) and internet prices are down 13%. And rising grocery prices are starting to abate after a 21% surge in overall prices from last year.

Grocery prices rose 2.4% y/y in February but this is the first time that food inflation grew at a slower rate than overall inflation since October 2021. With lower input prices (e.g., natural gas and fertilizer prices) and all the heat on grocery executives, food prices will moderate further in the coming months.

Canadian food price changes for February 2024

Source: Statistics Canada

A major contributor right now to inflation are shelter costs, and in particular, rising mortgage costs. Rents are up a steep 8.2% y/y but mortgage expenses are up a staggering 26%. If you strip out this cost, which is completely in the hands of the BoC, inflation is currently running at 2%, so job done!

What does all this mean? Interest rate cuts are coming!

Following this inflation report expectations rose for when the BoC will start cutting. Below is what the bond market is currently pricing in. The first cut is expected in June with current odds at 63%, up from 32% odds the week earlier. Then a few more cuts over the year.

Implied Cdn overnight rate and number of cuts/hikes

Source: Bloomberg

The question then is, how many cuts could we potentially see from the BoC in this next easing cycle? For that we need to look back at history.

Since the late 1990s we’ve seen six different times or cycles of the BoC cutting rates. As seen in the chart and table below, on average the BoC cuts five times over each cycle with an average decline in the overnight rate of 200 bps.

A few of these easing cycles occurred during a major economic downturn like in 2001 and ’08. In these instances the BoC slashed rates dramatically – 10 times in 2001 and 9 times in the 2008 cycle.

With our economy in much better shape today it’s doubtful we’ll see anything close to this in this cycle. More likely we’re looking like 1998 or 2015 when the BoC cut rates to help the slowing economy. So, I’m expecting fewer cuts in this cycle and see the BoC cutting maybe 4-5 times taking the overnight rate from 5% currently to low 4s/high 3s by the time they are done.

In fact, there’s potential for cuts until the first half of 2025, then the BoC moves to the sidelines and keeps rates steady, before potentially starting to hike later in 2025. This longer term projection is based on my expectations for the path of inflation, which is lower for now, but then potentially reaccelerating later in 2025, which could then force the BoC to begin hiking again.

But let’s not put the horse before the cart. Key point is that we’re at peak rates and readers can expect some relief on the interest/mortgage rate front in the coming months.

The implications of these rate hikes are: 1) variable mortgage rates look more appealing in this environment; 2) Canadian housing prices could rebound in the coming months; 3) stocks, and dividend stocks in particular, could rally on the cuts; and 4) our struggling Canadian economy could start to pick up later this year and into 2025.

So crack a beer (or a hoppy IPA for you youngsters) as interest rate relief is on the way!

Previous easing cycles from the BoC

Source: Bloomberg, Turner Investments

Details of previous easing cycles from the BoC

Source: Bloomberg, Turner Investments

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Investment Advisor, Private Client Group, of Raymond James Ltd.