BoC July Meeting Preview: More Cuts on the Horizon?

As the Bank of Canada (BoC) prepares for its upcoming meeting on July 24, market participants are keenly anticipating a potential interest rate cut following the easing cycle initiated on June 5. Recent macroeconomic data, particularly softer-than-expected inflation figures at 2.7%—a low not seen in over three years—has fueled speculation of a quarter-point rate reduction. In response to the latest inflation data, the swap market is pricing in a 90% probability of a cut at the July meeting.

Three main factors are driving the market's expectation for a rate cut:

Restrictive Rates and Inflation Dynamics: The real policy rate, which is the nominal rate adjusted for inflation—either the headline Consumer Price Index (CPI) or the Bank of Canada's favored core inflation metric—has reached its most constrictive point since late 2006, placing a drag on economic growth. Although key inflation readings still hover above the 2% target. Nevertheless, they still remain within the Bank's flexible control range of 1-3%.

Fed Rate Cut Expectations Could Ease Interest Rate Diverging Between Canada and US: The rate markets are priced for a divergence range of about 50-75 basis points between Canada's Overnight Repo Rate Average (CORRA) and the US Secured Overnight Financing Rate (SOFR), looking ahead to December 2026 futures. This projection is in line with historical trends and the current economic backdrop. Following the release of lower-than-anticipated US inflation data, the probability of a Federal Reserve rate cut in September has jumped to a certain 100%, increasing the hope for US rate cuts. This shift may reduce the interest rate gap between the two nations, potentially paving the way for the Bank of Canada to also lower rates at its July meeting.

Business and Consumer Sentiment: The recent business outlook survey shows that expectations for future sales among businesses continue to linger at historically low levels, with sectors reliant on discretionary consumer spending showing particular weakness. These are attributed to high-interest rates, weak demand for non-essentials, and persistent cost pressures. Additionally, a further deceleration is expected in the growth of their selling prices, a development that bodes well for the advancement toward the Bank's inflation objectives. The latest retail sales data also point to a weakening consumer sector, with nearly all industries and provinces experiencing declines, reinforcing the case for monetary policy support.

While there is a strong case for a rate cut, some analysts view it as a close call, citing the BoC's preferred core inflation measure, which remained unchanged at 2.8% year-on-year in June. If the BoC decides against a rate cut, it could be due to these stickier core inflation figures.

Additionally, the upcoming US election poses uncertainties for monetary policy, with potential inflationary effects depending on the policies adopted by a second Trump Administration. The BoC may opt to await the Federal Reserve's actions before proceeding with further rate reductions.