Canadian and US neutral rates are expected to partially converge by 2028, largely reflecting differences in the investment dynamics between the two economies, CIBC Capital Markets said in a Wednesday note.
A moderation in US artificial intelligence-related investment growth is expected to weigh on the neutral rate, while Canadian investment is anticipated to rebound from historically weak levels, supported by government initiatives, a more favorable regulatory environment and the advancement of large-scale capital projects, wrote Avery Shenfeld, managing director and chief economist of CIBC Capital Markets.
A neutral rate is "neither an economic tailwind or headwind, allowing the country to stay on its potential (non-inflationary) growth path," Shenfeld wrote.
Canada's more favorable demographic outlook is expected to support investment in housing, infrastructure and productive capacity, as the negative effects of declining non-permanent residents diminish, said the bank. On the other hand, tighter US immigration policies may reduce demographic support for growth and weigh on longer-term economic capacity.
As Canadian households complete the refinancing of ultra-low-rate mortgages after 2027, economic activity is expected to become less dependent on lower interest rates as a source of support for household spending. A rise in the Canadian neutral rate is expected to support a gradual policy normalization, though markets may be pricing in the adjustment too early, the bank said.
CIBC projects a 50-basis-point tightening cycle later in 2027, contingent on a sustained recovery in growth and the eventual closure of the output gap.
In the US, a lower neutral rate by 2028 suggests the Federal Reserve will need a more accommodative policy stance to get full employment. Although near-term inflation risks may warrant additional tightening, any rate increases are likely to be reversed as the neutral rate declines, leaving policy rates below current levels by 2028, according to the bank.
"That underlies our forecast that policy interest rates could also be closer to each other as we enter 2028 if events unfold in line with our forecasts," said Shenfeld.