It was just a few short months ago when an interest-rate hike from the Bank of Canada was all but a foregone conclusion, but instead, Mark Carney looks increasingly set for a 180-degree turn toward a rate cut Wednesday.
While hardly anyone expects an actual cut to borrowing rates, recent events, including Canada's shrinking second-quarter GDP and continuing chaos in the eurozone, could bring one back on the radar screen.
"It may not be 50%, but we're certainly close enough to a recession in the U.S., and by extension a spillover into Canada, that you'd have to give at least a third odds that we would be in a recession in December and facing a rate cut," Avery Shenfeld, chief economist at CIBC World Markets, said Tuesday.
Markets have certainly begun to price in the possibility of a cut, with yields on overnight index swaps suggesting a 64% chance of a cut by year-end, according to Bloomberg News.
The outlook for both the U.S. and Europe has turned decidedly sour since the bank's last announcement in July.
Europe has lurched into new fears about the future of the whole eurozone, with Italy backtracking on austerity measures, the bailout of Greece looking shaky amid demands for collateral and the whole sovereign credit crisis seeping into the banks of powerhouses like France.
Meanwhile, the United States posted no jobs growth in August, and any action to stoke the economy remains hobbled by the continuing political drama.
Mark McCormick, a currency strategist at Brown Brothers Harriman, said in a note that the United States and European Union account for 80% of Canada's monthly export total. However, as Canada's biggest trading partner, the United States accounts for the lion's share.
"A slowdown in Canada's major trading partners is likely to soften Canadian terms of trade, suggesting a widening of the output gap," he said.
Emerging-market countries have already acted to counteract the slowdown in global growth, with Brazil and Turkey surprising observers with rate cuts this month. That was a bit of a shock considering the focus for emerging markets has been on inflation.
A "substantial deterioration" in the global economy may be "prolonged" and could slow trade, investment and credit flows, the Brazilian bank said in a statement at the time. This echoes the most recent comments from central bank governor Carney at a parliamentary hearing in mid-August, when he also noted that global risks had intensified.
The latest Reuters survey of economists puts the median projection of a rate hike in the second quarter of 2012.
Michael Gregory, a senior economist at BMO Capital Markets, said the timing is not quite right for a rate cut.
"The odds of that happening (are) very low as it would have to be something on the ground now or pending," he said. "There has to be a more pressing urgency that the unravelling global economy is having a massive disinflationary influence on the Canadian economy."
There is a "tiny risk" of a cut, but the bank still needs more evidence, including how the Canadian economy responds in the third quarter.
