Bank of Canada neutral rate seen up in ‘Goldilocks’ shift for borrowing costs
BMO Capital Markets, RBC Dominion Securities and TD Securities have forecast that the Canadian central bank will raise its estimate of the neutral rate by 25 basis points to a 2.25 to 3.25 per cent range, with a midpoint of 2.75 per cent, at an economic update on April 10.
TORONTO — The Bank of Canada is likely to raise next month a key signpost for the level that interest rates are headed over time, in a potential blow to heavily indebted Canadians who got used to rock-bottom borrowing costs in recent decades, analysts say.
The neutral interest rate is the level where short-term rates are expected to settle once economic shocks fade and inflation goes back to normal.
BMO Capital Markets, RBC Dominion Securities and TD Securities have forecast that the Canadian central bank will raise its estimate of the neutral rate by 25 basis points to a 2.25 to 3.25 per cent range, with a midpoint of 2.75 per cent, at an economic update on April 10.
That’s a signal that borrowing costs are unlikely to fall as much as in previous easing cycles, a shift that could also play out in other major economies, say analysts.
But Canada’s economy is particularly sensitive to higher borrowing costs, with household debt at more than 180 per cent of disposable income compared to about 100 per cent in the United States, OECD data shows, much of that to participate in a redhot housing market in recent years.
Federal and provincial governments have also borrowed heavily to pay for pandemicrelated expenditures. The federal budget is due to be presented on April 16. Businesses could also be facing rates that are higher for longer.
“It would all play into a bit more caution on how far and how quickly they would ease rates,” said Robin Marshall, director of fixed income research at FTSE Russell.
“There are factors here that I think suggest we might be going back to more of a Goldilocks-type cycle on rates,” Marshall said, referring to the fairy tale about a little girl who liked her porridge neither too hot nor too cold.
Interest rates will probably run between three and five per cent rather than zero to three per cent as they did before the global financial crisis in 2008-09, Marshall said. Money markets expect rates to settle at about 3.3 per cent in the coming years, futures data shows, well above the Bank of Canada’s current 2.5 per cent estimate for the neutral rate.
The central bank has said that shifts in the global balance of savings and investment due to the retirement of baby boomers, a slower pace of globalization and the transition to a low-carbon economy, as well as advancement in artificial intelligence, creates a “meaningful risk” that the neutral rate moves up.
It has already lifted the neutral rate once, in April 2022, after cutting it to 2.25 per cent during the pandemic. But the rate had previously fallen steadily from a five per cent level before the global financial crisis.
The Bank of Canada is expected to leave its benchmark interest rate, the target for the overnight rate, on hold today, after raising it to a 22-year high of five per cent to cool inflation, but it’s then expected to begin a rate-cutting campaign in April or June.
“The fact that we had high overnight rates, tight monetary policy and less of a downward trend in inflation than anticipated, to me suggests that neutral rates are probably a little higher than anticipated,” said Andrew Kelvin, chief Canada strategist at TD Securities.
The U.S. Federal Reserve’s estimate for its neutral rate is also at 2.5 per cent, but at least one Fed official sees it as high as 3.8 per cent, the central bank’s most recent quarterly projections showed in December.
“The pandemic-type rates of near zero, from the Bank of Canada’s perspective ... those are a relic of the past for now,” said Benjamin Reitzes, Canadian rates & macro strategist at BMO Capital Markets.