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federal reserve rate cut

Will a Fed Rate Cut Put More Pressure on the Bank of Canada?

South of the border, the Federal Reserve is almost certain to cut interest rates tomorrow for the first time since the financial crisis a decade ago, according to market odds.

Should the Fed opt for a pre-emptive rate cut to ward off a potential economic slowdown, the Washington Post said it would be the central bank’s “biggest gamble in years,” given that the U.S. economy is still expanding at a healthy 2.1%.

However, some economists say the Fed needs to cut aggressively—by 50 bps rather than 25 bps—if it truly wants to be pre-emptive and stave off a slowdown.

“When you think about the job market, right now the momentum is already slowing…and the impact of the global slowdown will show further on the [capital expenditure] numbers, further on the job market,” Morgan Stanley’s Chetan Ahya told CNBC. “So, if the Fed wants to be pre-emptive, it needs to cut 50 basis points.”

Even U.S. President Donald Trump weighed in with a Tweet on Monday saying, “a small rate cut is not enough.”

While a quarter-point cut is the most likely outcome tomorrow, markets are currently forecasting a total of two to three 25-bps reductions by the end of 2021.

The Road Ahead for the BoC

Bank of Canada financial buildingOn this side of the border, a U.S. rate cut could add to headwinds already facing the Bank of Canada, which is coming under pressure of its own to cut rates.

“If the Fed cuts, there will be a natural policy pressure for the Bank of Canada to move that way,” TD’s senior FX strategist Mazen Issa told Reuters.

While recent data shows the Canadian economy is returning to potential growth, heightened trade tensions continue to present a risk to the economic outlook, the bank confirmed following its June rate decision.

“While we agree that the Bank [of Canada] will sit on its hands in the coming quarters, we believe that it will eventually ease by 25 bps during the course of 2020,” noted CIBC’s Benjamin Tal in a research note.

“The BoC is telling us that monetary policies are diverging due to the fact that the Canadian and the U.S. economies are converging,” he added. “That might be true from a short-term cyclical perspective, as the dismal performance of the fourth and first quarters in Canada gives way to a strong rebound in Q2. But from a more structural perspective, we see no convergence.”

Do Low Rates Present a Risk?

While a rate cut—or cuts—from the Bank of Canada would be welcome news for borrowers with adjustable-rate mortgages and lines of credit, it could also serve to reignite the country’s housing market and drive up household debt, say some observers.

East of Manitoba, house prices are already showing signs of rebounding from weakness experienced earlier in the year, according to the latest data from the Canadian Real Estate Association. In Ottawa and Montreal in particular prices are soaring at annual gains of 7.6% and 6.4%, respectively.

“The soft landing is behind us,” Fred Demers, a director at BMO Global Asset Management in Toronto, told the Financial Post. “When you think about the GTA and Canada in general, we’re looking more at a re-acceleration.”

He added that the high level of household debt “remains a big concern,” and that the pace of credit growth would likely pick up in the second half of this year.