Rosenberg Research & Associates Inc. argues that the Bank of Canada's neutral interest rate may be as much as 50 basis points too high, meaning the central bank could cut rates further without stimulating the economy. A 50-basis-point reduction would lower the neutral range to 1.75 per cent to 2.75 per cent from the current 2.25 per cent to 3.25 per cent, which the Bank of Canada reaffirmed in April.
Evidence for a lower neutral rate
David Watt, senior vice president and director of economic research at Rosenberg Research, said in a note on July 9 that there is “more than enough evidence to suggest that the neutral range might actually be lower, possibly by as much as 50 basis points.” Under a lower neutral range, the current policy rate of 2.25 per cent would not be as stimulative as it appears, he added.
The neutral rate is the interest rate that neither stimulates nor slows the economy. The Bank of Canada has held its overnight lending rate at the bottom of the current range at 2.25 per cent for the past five decisions.
Watt pointed to weak economic growth, little pressure on wage growth, and core inflation near the Bank of Canada's two per cent target as evidence that the neutral rate could be too high. He also noted that recent economic developments are expected to weigh on Canada's neutral rate, further supporting a lower estimate.
Demographic and structural factors
Population growth contracted at the start of the year for the first time on record due to immigration cuts, while natural population growth stalled. The federal government has planned further cuts to non-permanent residents into 2027, which Watt said will shrink the labour force. Meanwhile, permanent resident immigration has slowed, and economic immigration is below Ottawa's target, feeding into “downside risks” to the neutral rate.
Other structural developments include a slowdown in machinery and equipment investment compared with the United States, where it has risen for the last 30 years. The non-renewal of the Canada-U.S.-Mexico Agreement, triggering a decade of reviews, means companies face years of ongoing trade friction that will leave businesses reluctant to make long-term plans.
Watt noted that even though Canadian exports (except lumber, autos, aluminum, and steel) face the lowest tariff rates compared with other countries trading with the U.S., businesses should be prepared for further attempts to erode those protections given the U.S. administration's activism on trade and tariff issues.
The Bank of Canada announces its next interest rate decision on July 15.
