What history can tell us about soft landings and the pace of rate cuts that usually follow

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Skeptics have long questioned whether the Bank of Canada could navigate the delicate balance required for a so-called ‘soft landing,’ a scenario where the economy slows just enough to curb inflation without tumbling into a recession.

Despite these doubts, Canada has so far managed to avoid the dreaded R-word, traditionally defined as two consecutive quarters of negative GDP growth.

And contrary to skepticism, the Bank of Canada actually has a proven track record of successfully managing soft landings more often than not.

“Soft landings in Canada aren’t as rare as many think,” CIBC economists Avery Shenfeld and Ali Jaffery wrote in a recent research paper, which also explored the historical pace of rate cuts that tend to follow these soft landings.

“But memories are fickle, and we typically recall the most dramatic economic turning points, and forget outcomes that generated less turmoil,” they continued. “As a result, there’s a tendency to focus on major easing cycles that came amidst deep recessions, while failing to take note of smaller adjustments in rates that came in time to forestall such downturns.”

Since the 1980s, more than half of Canada’s easing cycles have been associated with “soft or ‘softish’ landings,” the CIBC economists note. And when looking specifically at the time period since the 1990s when inflation-targeting was formalized, “the Bank’s record of achieving soft landings is even better.”

Then there are the hard landings that were caused largely by external shocks, including the 1990 Gulf War and the Global Financial Crisis in 2008-09, where the central bank arguably shoulders less of the blame.

By comparison, the U.S. Federal Reserve hasn’t been as successful. Shenfeld and Jaffery note that true soft landings were only achieved in the U.S. in the easing cycles that began in 1984 and 1995.

What history can tell us about the coming easing cycle

The CIBC economists also say history can provide some insight into what the pending rate easing cycle may look like.

Soft landings, they say, typically lead to a soft and gradual pace of rate cuts.

“All of these easing cycles started with monetary policy in a restrictive stance, with the policy rate above what we now know as neutral,” they wrote. “In general, the overnight rate was back to neutral in one to two years.”

The one exception, they noted, was the 2014 oil price shock where rates were already below neutral and stayed below throughout that period.

How does this all apply to today?

On average, easing cycles in Canada take place over approximately six quarters before rates return back to neutral, the report says.

“In the current circumstances, that would have the Bank of Canada take rates to somewhere in the 2.5% to 3% range by late 2025, assuming the first easing is in mid-2024,” it goes on.

But there are some differences between past easing cycles and today’s situation.

For one, in recent easing cycles inflation was nowhere near the level it reached this time around, peaking at a rate of 8.1% in June 2022.

And despite the progress to date of bringing inflation back down, both central banks in Canada and the U.S. are still on guard against inflation becoming “stuck” above its neutral range.

On the other hand, the CIBC economists argue that the central banks may also speed up the pace of rate cuts to reverse weak demand once they are assured that inflation has returned to target.

“The will to crash the economy to bring inflation down rapidly is simply not there anymore,” they say. “The lengthy recovery during the post-GFC period and the initial slow response to the inflation surge in the post-COVID era were indicative of a change in philosophy to ensure sufficient support to demand.”

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