Posthaste: Why the Bank of Canada may have to cut rates deeper than its global peers
It’s been quite the week — Donald Trump’s victory in the United States election sent stocks soaring and gold plunging yesterday, and today the Federal Reserve announces its rate decision.
The Fed is widely expected to cut 25 basis points after reducing its rate by a half point in September. But with interest rates starting to come down in the world’s major economies, there’s been a lot speculation about how low they will go.
An analysis by Capital Economics reckons the United States, United Kingdom and Australia will cut interest rates to an equilibrium or neutral rate — where borrowing costs neither stimulate nor restrict an economy — of 3 per cent.
But rates in Canada and the eurozone will likely have to be cut further, below the neutral rate, to 2 per cent and 1.5 per cent, respectively, said Capital.
“This judgment reflects our view that economic weakness and spare capacity in the latter two economies will warrant policy support,” wrote Jennifer McKeown, Capital’s chief global economist.
Capital expects core inflation will be back on target by this time next year for all major advanced economies except Japan. Therefore, it is the state of the economy that is most likely to drive rates in the future.
Capital’s chart suggests the economies of Canada, the eurozone and Japan are operating below potential and they expect a negative output gap to continue through 2025.
“Our estimated Taylor Rules suggest that interest rates ought to fall to around equilibrium in the U.S., U.K. and Australia next year. But they should fall below that rate in Canada and the eurozone as economic weakness convinces their central banks that monetary policy stimulus is needed,” said McKeown.
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