A rate cut could ease funding costs for banks and mitigate rising interest payments on mortgages
Investors on Toronto’s Bay Street are increasingly betting on a June rate cut in Canada, which could boost Canada’s bank stocks, according to the Financial Post.
The S&P/TSX Banks index has risen just 0.9 percent this year, compared to a 6.7 percent gain for Canada’s benchmark S&P/TSX Composite. High interest rates, a wave of mortgage renewals, and rising loan losses have challenged the banking sector.
Over the past five years, the banks index gained 19 percent, about half of the broader Canadian stock gauge's 37 percent surge.
Optimism is growing for Canada’s largest market sector as a cooler-than-expected inflation report in May increased the chances of a June rate cut to 65 percent from 40 percent a week earlier.
Investors expect Canada’s central bank to lower rates ahead of the United States Federal Reserve due to the high indebtedness of Canadian households and slower growth.
“What the rate cuts will mean for an economic outlook is much more positive,” Jefferies LLC analyst John Aiken said. “Given the Canadian banks are a beta play on the Canadian economy, anything that helps the Canadian economy will be beneficial to their bottom line.”
Banks can expect some relief as the first rate cuts roll in, easing their cost of funding. While some loans will reprice with a lower policy interest rate, they will still have a higher rate compared with two years ago. Even if it is a moderate impact, it is still beneficial.
Bank of Nova Scotia will report results on Tuesday before North American markets open, following Toronto-Dominion Bank, which exceeded analyst expectations last Thursday.
A recent rally in bank shares suggests the potential upside from a rate cut is already priced in, said IG Wealth Management Chief Investment Strategist Philip Petursson.
“I certainly wouldn’t be trading on the potential for a Bank of Canada cut to say, ‘Oh, this is gonna provide a meaningful lift for financials,’” he said.
Others are more optimistic. Greg Taylor, chief investment officer of Purpose Investments, believes a rate cut would lift sentiment for Canadian banks and help mitigate housing problems.
Last week, Canada’s banking regulator warned homeowners renewing their mortgages might face dramatically rising interest payments. The Office of the Superintendent of Financial Institutions noted that 76 percent of outstanding mortgages as of February are up for renewal by the end of 2026.
Prolonged elevated rates will strain these households, posing a risk to banks holding these mortgages. Peter Routledge, the superintendent of financial institutions, likened the wave of upcoming renewals for variable-rate mortgages with fixed payments to a “mouse in the snake” — an issue banks must manage.
