10:40 AM EDT, 11/01/2024 (MT Newswires) -- Without sounding like we are talking our book -- 2% terminal, another 50bp in December, and a coin flip on 50bp in January -- there is strong rationale for the Bank of Canada to move fast on interest rate cuts, according to an RBC Canada Rates Strategy note published Friday.

RBC said the BoC is "arguably more behind the curve than ever before and rapid rate reductions over the next few months will only serve to get them to the curve, not ahead of it".

Why, RBC asked, does it matter?

RBC noted the BoC is usually cutting when excess demand is falling. It said this cycle they are very late, which was necessary to squeeze inflation out of the system. "Consider that if the current inflation backdrop was present last summer the BoC would probably have started cutting then and maybe already completed the easing cycle by now," the bank added.

"Let's assume," RBC said, "the BoC is right and inflation risks are balanced (downside risks more pronounced in our opinion). With low inflation that means growth and output gap assessments take on added weight in their policy decisions. Their historical compass (output gap) is saying to speed up rate reductions. While the BoC may ultimately react to "large" data surprises in determining the size of the move each meeting, we think the bar has been set. Data needs to come in hotter than their forecasts to justify a downshift to 25bp cuts."

RBC added: "Disinflation risks won't dissipate until excess supply is absorbed, which requires a period of sustained above trend growth (they have told us this is their desire). The BoC estimates the output gap at -1.25% (range of 0.75% to 1.75%), which means that GDP needs to exceed potential by an equivalent amount over one or half the amount over two years to absorb excess supply. How is that going to happen given the growth track record the last 2 years and a policy setting that is still restrictive? The BoC even noted in the MPR that they did not expect slack to be absorbed until H2-2025. Their above consensus near-term projection simply would keep the level of excess supply unchanged."

RBC said it had always argued the BoC would be as late to easing as they were to tightening. "While they don't need to cut as quickly as they hiked (75bp or 100bp clips) given the asymmetry in high vs low inflation costs, 25bp seems woefully insufficient. This framework underscores our current forecasts and reinforces what the Fed does (small or large cumulative cuts) is largely irrelevant to Canada's policy cycle."