Thought of the day

The Bank of Canada lowered its benchmark overnight rate by 25 basis points to 4.75% on Wednesday, the first G7 central bank to kick off an easing cycle, as policymakers have become more confident that inflation is headed to their 2% target. Data last month showed the annual inflation rate in April slowed to a three-year low of 2.7%, with core measures—which exclude volatile food and energy prices—continuing to ease.

“With further and more sustained evidence that underlying inflation is easing, monetary policy no longer needs to be as restrictive,” Governor Tiff Macklem said. Policymakers added that it’s reasonable to expect further cuts if progress continues.

While Macklem stressed the timing of the next cut would depend on whether inflation continued its downward trajectory and whether the economy evolved in line with the bank’s expectations, we view this as another step forward in the global rate-cutting cycle after the Swiss National Bank and Sweden’s Riksbank earlier this year.

In fact, the European Central Bank (ECB) is widely expected to make a similar move at its policy meeting today, and we believe the Bank of England (BoE) and the Federal Reserve are next in line.

The inflation bump in May is unlikely to derail the first ECB cut today. The increase in Eurozone inflation in May will likely be a cause for debate among policymakers at the ECB today, with higher services price pressure suggesting that underlying inflation momentum could still be quite firm. However, we still think the ECB will embark on its cutting cycle today, with recent comments from members of the Governing Council pointing to a near certainty. Reversing course at this point could upset market expectations about the central bank’s future direction, and the increase in inflation was not sharp enough to justify such a change in policy, in our view.

The Bank of England should follow suit over the summer. With BoE members having adopted a more dovish tone over recent months, we think the central bank is getting closer to a rate cut. While higher-than-expected inflation in April means the central bank is unlikely to move for a couple more months, it remains the lowest rate since September 2021. We expect the BoE to ease in August, with another two to three cuts over the course of the year. The July elections are not expected to have much impact on monetary policy.

Fed easing should find support in recent data that point to a cooling economy. While the US services sector snapped back into growth mode in May, according to the latest ISM survey, the country’s manufacturing activity contracted further. Data from the ADP Research Institute showed hiring at US companies in May grew at the slowest pace since the start of this year, while April’s jobs openings and labor turnover survey (JOLTS) saw US job openings fall to the lowest level since February 2021. Combined with the latest inflation prints that suggest a return of the disinflation trend, we continue to expect the Fed to start lowering rates in September, with a total of 50 basis points of cuts this year.

Once these central banks begin easing policy, it is likely to be the start of a cycle that should see rates some 150 to 200 basis points lower from the peak by the end of 2025, in our view. This means current returns on cash will not be available for much longer, and investors holding cash or money market funds, or those with expiring fixed-term deposits, should consider managing their liquidity through bond ladders, structured investment strategies with capital preservation features, or balanced equity-bond portfolios.