02:15 PM EDT, 07/19/2024 (MT Newswires) -- Alongside a quarter point rate cut that "won't surprise anyone", the Bank of Canada is set to unveil its revised economic outlook next Wednesday, noted Avery Shenfeld in his regular 'The Week Ahead' column published Friday.

But, according to Shenfeld, for market participants looking for clues on what lies ahead, the Monetary Policy Report will read like a "partially redacted intelligence agency release, with some of the juicy bits covered up". In contrast to the US Fed's statement, he noted, there's no interest rate forecast to be found, and no unemployment rate projection. So Shenfeld has provided a guide to what lies in those blackened out sections, as well as what the Bank will be free to say.

Shenfeld said: "In cutting rates a second consecutive time, it will rightly argue that it needs to look past every little blip in the CPI, and focus instead on two key elements of the 'big picture'. First, the economy is now operating with visible disinflationary economic slack, as evidenced by labour market softness and an extended run of mediocre growth that has trailed the Bank's estimate of the economy's non-inflationary potential. Current interest rates would be a hurdle towards any improvement, with the Bank likely to again mention mortgage renewals as a drag ahead.

"Second, considerable progress has been made on inflation in the past year, and the conditions are in place for that to continue. While they might not single it out, mortgage interest costs now represent the lion's share of the gap to the 2% target, and rate cuts will bring that component of the CPI down sharply. Wages

are still looking overheated, but in line with what the Bank's Business Outlook Survey showed, they should cool next year in a lagged response to softer inflation and labour market slack.

"So the Bank will confidently predict that the headline CPI will sit at 2% by the end of next year. In effect, its message is, don't worry, we've got this. The GDP forecast could concede a bit of sluggishness in the next couple of quarters. But easier financial conditions will drive a call for above-potential real GDP growth

in 2025, likely a shade under 2.5% on a Q4 over Q4 basis, so that the output gap will be eliminated by the end of next year. Governor Macklem has repeatedly said he can get to the inflation target without a recession, and he's not going to give up on that pledge just yet.

"The catch in this is that the Bank's estimates for potential growth have been all over the map. Population and labour force growth is supposed to decelerate next year, and productivity should rebound, but how that will impact potential output is highly uncertain.

"That's where one of the redacted items in the MPR kicks in. The Bank's estimates of slack in GDP terms have been partly influenced by more visible measures of labour market slack. The job vacancy rate is near its historical norms, but a climbing 6.4% unemployment rate is well above the roughly 5.7% level that proved to be noninflationary in the last cycle. The Bank's GDP projection will effectively be what it sees as achievable while getting the unemployment rate back to that full employment level.

"Therein lies the clue to the other redacted item, the expected path for policy rates. An economy sitting at full employment and on-target inflation will in theory be one requiring interest rates to be at a neutral setting, which the Bank (and CIBC) see at 2.75%. Barring an economic shock, that's a reasonable

forecast for where 2025 will end up.

"That also implies that we won't need a move at each and every rate setting date. Without much to guide us, months ago, we pencilled in the first pause in September, with cuts in June, July, October and December of this year. As we've seen in the CPI news, economic data don't follow a straight line path, and such pauses are more likely to be seen if there is a non-trivial upside surprise in employment, growth or inflation.

"But since neither we, nor the Bank, can know when those blips will show up, even a fully unredacted Monetary Policy Report wouldn't be able to accurately provide that level of detail on the rate path ahead. We'll see if the press conference drops any hints, but September might well see another cut, with the pause pushed out to December. By then, rates will have dropped a full percentage point, giving more reason to pause and let the data show the need for a full percentage point, giving more reason to pause and let the data show the need for a further easing."

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