Skip to content

Canada's Economy Slows Down in Q2, Bank of Canada May Pause Rate Hikes

The Canadian economy is expected to show a significant slowdown in the second quarter, which may lead the Bank of Canada (BoC) to halt its interest rate hikes despite recent inflation surges.

Bank of Canada
Bank of Canada

Sharp Slowdown in Canada's Economic Growth

A Reuters poll of economists indicates that Canada's second-quarter GDP report, to be released on Friday, is likely to reveal a significant slowdown in economic growth. This could prompt the Bank of Canada to pause its interest rate hikes, despite recent higher inflation data. The GDP report is crucial as it is the last major piece of domestic data before the Canadian central bank's next policy decision on September 6. It is predicted to show the economy growing at a 1.1% pace in the second quarter, a decline from 3.1% in the first quarter, and below the BoC's 1.5% estimate.

Inflation Rise and Market Relief

The market might find relief in the slowdown as the latest CPI report indicated inflation rose above 3% in July, further deviating from the BoC's 2% target and increasing expectations for another rate hike in September. The BoC, which raised its benchmark rate to a 22-year high of 5% in July, has stated it will closely examine economic data before deciding on further interest rate increases.

Transitory Factors Affecting Economic Slowdown

The expected slowdown in the second quarter might be partially attributed to temporary factors such as wildfires, energy project maintenance, and a civil servants' strike. This means that a preliminary estimate for July, released on the same day as the quarterly data, will also be crucial for the rate outlook, according to analysts.

Possibility of Holding Interest Rates

Analysts like Benjamin Reitzes, Canadian rates & macro strategist at BMO Capital Markets, suggest that if there are clear signs of economic slowing, the BoC may find it reasonable to maintain the 5% interest rate for the time being and await more data. Money markets currently see a roughly 70% chance that the BoC will pause in September but lean towards further tightening by year-end, resulting in interest rates peaking at 5.25% in the current cycle.

Impact of Dock Workers Strike on July Estimate

The July estimate is crucial as it follows recent preliminary data showing a contraction in June activity, which could be influenced by a dock workers' strike last month at ports along Canada's Pacific coast. Stephen Brown, deputy chief North America economist at Capital Economics, suggests that the combination of a likely GDP drop in June and port strikes in July raises the chances of a negative GDP print for Q3.

Diverging Opinions on BoC's Next Move

While the BoC has projected 1.5% growth for the third quarter, matching its second-quarter estimate, not all economists anticipate a pause in rate hikes. Some, like Andrew Grantham, a senior economist at CIBC Capital Markets, argue that the composition of growth in the second quarter, including the split between internal and external demand, could also be a factor. Grantham suggests that if domestic demand remains strong, led by a rebound in housing and consumer spending on services, and if the July figure indicates a good start to Q3, the BoC may still opt to continue hiking interest rates at the September meeting.