Analysts predict that the Bank of Canada will accelerate its interest-rate reduction efforts after U.S. employment was weaker than expected in July.

American non-farm payrolls increased by 114,000 jobs in July and the unemployment rate rose to 4.3% from 4.1%, the highest since October 2021, the U.S. Labor Department reported Friday. The unexpected results will prompt the U.S. Federal Reserve to cut the American prime rate by 25 basis points at each of its next two meetings, Bloomberg reported.

The Canadian and American economies are closely aligned; therefore, the BoC and Fed’s interest-rate policies usually follow a similar path. But that path started to diverge earlier this summer as the BoC announced two rate cuts and the Fed stood pat with holds.

Financial experts anticipate that a weaker U.S. economy will give BoC Governor Tiff Macklem confidence to introduce more cuts at a faster pace to reduce borrowing costs.

The reality is that the BoC started cutting interest rates well before the Fed did, and now the U.S. central bank has to catch up, Carl Gomez, CoStar Group’s chief economist and head of analytics for Canada, told Connect in an interview.

“The difference has been, obviously, that they’ve been late to the game, because the U.S. economy is much stronger than the Canadian economy,” said Gomez. “They’re seeing a tighter job market, more pockets of inflation flowing through, and stronger growth.

“But even there, I think with easing inflation risk, you’re going to start seeing the US Fed, and the second half of this year, September, could be December, joining the Bank of Canada with rate cuts.”

As a result, he added, the BoC does not have to worry about a flight of capital out of Canada that would cause the Canadian dollar to sink.

“I don’t think that’s really the case,” said Gomez. “The market is pricing in rate cuts, both for the Federal Reserve and the Bank of Canada. So, this is not one where the Bank of Canada is going to completely diverge from the U.S.”

The U.S. market has seen a notable shift in rate-cut expectations, now betting that the Fedwill start easing policy in September with a 50-basis point reduction, versus what was seen before the report as a 70% chance of a quarter-point cut. 

“This is what a growth scare looks like,” Wasif Latif, president and CIO at Sarmaya Partners, told Reuters. “The market is now realizing that the economy is indeed slowing. Unemployment is an auto-correlation number.

“So, once it starts moving in a certain direction, it generally continues to move in that direction for some successive data points. I think the market is also quickly realizing the Fed may have made a mistake by not cutting.” 

The unexpected sharp rise in the jobless rate triggered the Sahm rule, which says that if unemployment, based on a three-month average, rises by at least a half percentage point over the past 12 months, the nation is probably in a recession. 

It typically takes a year to determined whether a country is in a recession, based on how the data unfolds. U.S. interest-rate cuts will give the BoC a green light to keep cutting its reates Benjamin Reitzes, rates and macro strategist at Bank of Montreal, told Bloomberg.

A mid-July Bloomberg survey showed that analysts expected the BoC to cut its key policy rate to 3% from the current 4.5% by year-end 2024. But following the release of the U.S. labour data, Bank of Montreal’s Douglas Porter predicted in a research note that Macklem will cut the policy rate at each of the next four BoC meetings.

“That means the bank will arrive at the presumed end point more than half a year earlier than expected,” Porter said, according to Bloomberg.

Pictured: Bank of Canada Governor Tiff Macklem