BoC rate cuts still likely despite inflation concerns, says Desjardins' Mendes

The Bank of Canada is caught in a tough spot as it weighs future interest rate cuts, balancing a potential weakening of the economy with fears about rising inflation.

But inflation concerns have been overstated by temporary factors, clearing the way for the central bank to deliver more aggressive interest rate cuts as the economy struggles with weak demand and rising unemployment, according to a new analysis from Desjardins Group economist Royce Mendes.

Mendes said in an interview with Yahoo Finance Canada that most signs of problematic core inflation can be traced to “a few very idiosyncratic one-off factors” that converged in April’s consumer price index data, creating what he calls an “illusion” of persistent inflation pressure.

“I think it’s really time to move the inflation worries to the back burner and start focusing, in terms of Bank of Canada policy or fiscal policy, on supporting the economy, with the unemployment rate near 7%,” Mendes said.

The economist identifies three temporary factors that artificially inflated April’s core inflation reading: a sudden surge in official rent data that has not yet caught up to falling market rents, energy providers raising prices after carbon tax removal, and the peak impact of retaliatory tariffs.

Markets underestimating further cuts

With those pressures easing, Mendes believes markets are not fully pricing in how much additional monetary stimulus the Bank of Canada will provide. Current unemployment sits at 6.9% as of July, while consumer inflation has declined to 1.7% year-over-year.

“What you should expect to see is that shorter-term bond yields, money market interest rates will see an adjustment that is not currently anticipated or implied by current market pricing,” he told Yahoo.

The assessment aligns with recent business sentiment data from Statistics Canada, which show 62.2% of businesses expect cost-related obstacles over the next three months, down from 65.4% in the previous quarter.

Economic challenges persist

Despite the improving inflation picture, Canada’s economy faces significant headwinds. Real gross domestic product edged down 0.1% in May for a second consecutive month, while overall employment fell by 41,000 positions in July.

BMO chief economist Doug Porter has also noted that proposed US tariffs could push Canada into recession, potentially forcing the Bank of Canada to cut rates at each meeting through October. Under such a scenario, the benchmark rate could fall to 1.5% from the current 3%.

Statistics Canada’s latest business survey reveals mixed sentiment, with 66.7% of businesses remaining optimistic about their 12-month outlook, though only 13.8% expect sales increases over the next three months.

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