GRI hosted an insightful discussion with Warren Lovely (National Bank of Canada) and Christopher Ragan (McGill University) on the 2025 outlook for Canadian monetary policy. 

Warren began by highlighting the ongoing Bank of Canada (BoC) easing cycle, which has led to a cut of 175 basis points in the policy rate since June 2024. This trajectory is moderate relative to previous Canadian cycles but more aggressive than that currently observed in the U.S., which might reflect underlying economic weaknesses in Canada. Warren noted the divergence between the levels of the Canadian and U.S. policy rates and bond yields, with the 2-year yield differential at 135 basis points, the widest since the mid-1990s. He expressed concern over the potential impact of diverging monetary policies on FX markets and the value of the Canadian dollar.

Addressing broader challenges, Warren acknowledged Canada’s inflation, fiscal and political risks, but he also emphasized that Canada might have a more sustainable fiscal path compared to other advanced economies. He anticipated more conservative fiscal policies going forward, although defence spending could lead to some additional government spending. He concluded by discussing balance sheet management and quantitative tightening expectations for 2025, suggesting that the BoC would likely approach the lower end of its neutral policy rate range over the next year.

Christopher transitioned to a theoretical exploration of the neutral interest rate, defining it as the prevalent rate when the economy is in equilibrium; that is, when real GDP equals potential GDP, inflation is at its target, and the economy has adjusted to past macroeconomic shocks. He illustrated the neutral rate concept by discussing the interplay between national savings supply and national investment demand. Christopher outlined key drivers behind declining neutral rates since the 1990s, such as declining productivity growth and physical capital investment, and the rise in income inequality and life expectancy.

Looking ahead, he identified forces that could increase the neutral rate over the next decade, including increased government spending (e.g., on the elderly, infrastructure, and military) as well as private and public sector investments in energy transition. Lastly, Christopher emphasized that while the BoC may implement cyclical rate cuts in the near term, structural factors may limit the potential for significant long-term rate reductions, with the possibility of rates increasing over the next decade.