07:14 AM EDT, 09/24/2024 (MT Newswires) -- Bank of Canada Governor Tiff Macklem recently hinted that a larger rate cut of 50 basis points may be appropriate in the coming months, said Commerzbank.

The market has already priced this in quite well, with expectations having corrected "significantly" in recent weeks, wrote the bank in a note to clients. The market now expects a cut of around 25 basis points at each of the next seven meetings.

A move of 50 basis points at each of the next two meetings is even priced in with a probability of around 50%, stated Commerzbank. If that happens, the BoC would have halved the key rate in just under 15 months by the middle of next year.

At first glance, this acceleration may seem surprising, pointed out the bank. After all, the BoC has already cut rates three times by 25 basis points over the last couple of months, putting it in the middle of the G10 pack on policy rates, while other central banks are still hesitating.

However, there are good reasons for this. Canadian headline inflation has recently fallen back to the middle of the BoC's target range, at 2% year-on-year. This decline hasn't been driven by one-off blips or base effects; rather, inflation has fallen on a sustained basis.

As a result, inflation in Canada is now only slightly above the average for the 2010s. At the same time, Canada's policy rate, currently at 4.25%, is well above the 2010s average of just under 1%.

In short, Canadian monetary policy is currently much tighter than it was in the 2010s, added the bank. This is also reflected in the fact that market -- short-term -- inflation expectations have recently collapsed. At just under 1%, one-year expectations are now even below the average of the 2010s.

Accordingly, the Canadian real interest rate has barely declined despite the rate cuts, in stark contrast to its United States counterpart after the last rate cut.

In the short term, a more restrictive monetary policy than necessary can have a stabilizing effect on the Canadian dollar, according to Commerzbank. In the medium term, however, the picture is likely to be different. The bank is already seeing clear signs of a slowdown in the labor market. Growth is no longer as strong as it once was.

As a consequence, there is a strong case for Canada's central bank to accelerate the pace of rate cuts in the coming months -- and the Canadian dollar is likely to suffer again.