Out of 23 economists, 17 believe that the Bank of Canada (BoC) will lower interest rates at least twice more this year. However, the market is only expecting one rate cut. The BoC has been making significant rate cuts and has taken precautionary measures due to trade tensions. Since last December, Canada’s inflation rate has been rising steadily.

Effects Of Inflation On Rate Cuts

The easing of trade war tensions and the BoC’s strong monetary actions might keep inflation rising. Because of this, the market does not expect a second rate cut, and if the economy improves, predictions for additional cuts may also be off the table. A rate hold by the BoC is expected in the next decision. Given recent inflation challenges, the central bank is likely to take a more cautious approach. In short, while economists still predict at least two more interest rate cuts in Canada this year, the broader market seems less confident. The central bank has already made moves that should normally boost consumer and business lending to prepare for weak exports and potential economic shocks. However, inflation data complicates this situation. Since December, prices have steadily increased. This rise is likely supported by more stable global trading conditions, especially with reduced protectionist actions. Meanwhile, previous rate cuts are still impacting the economy, making it more challenging for inflation to align with policy goals. As a result, traders have a limited view on future actions. Short-term rate futures have already dismissed the chance of two cuts, instead pricing in a lower likelihood of further easing. Expectations have changed. If growth data is better than expected or even just does not decline, confidence in additional cuts could fade further. Regarding the next policy decision, most expect the benchmark rate to stay the same. Reading between the lines, it seems the central bank is subtly adjusting its approach. If inflation continues to exceed targets, discussions about raising rates could re-enter the conversation, which would have seemed unlikely in the spring.

Implications For The Canadian Dollar

We should closely monitor forward guidance when it is released. Central bankers, particularly Macklem and his colleagues, seem ready to lightly counter expectations of more easing, especially since they have already acted decisively this year. Statements after the announcement will be more important than usual. Any positive updates on inflation or comments suggesting patience could quickly change rate expectations. Instead of searching for hints in general preferences or political issues, we should focus on key data points that the central bank relies on for its decisions: wage growth, shelter costs, and inflation in the service sector. If these indicators strengthen even slightly, they could challenge any bearish views still present in the market. We also need to watch how the Canadian dollar reacts. Currency movements often reflect interest rate trends, and a stronger loonie might give the BoC another reason to pause. This is not solely out of fear of the currency’s strength but because a robust currency can naturally tighten financial conditions, which the bank has been keen to avoid. As for strategy, those holding rate-sensitive contracts should prepare for limited immediate changes but anticipate volatility around future inflation data and bank official speeches. It’s important to remember that unexpected inflation can tighten yield curves rapidly. In the coming weeks, we need to watch data releases closely. If numbers indicate that rising prices are becoming persistent, we expect the sentiment in fixed income pricing to shift further away from rate cuts entirely. Create your live VT Markets account and start trading now.

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