By Fergal Smith

TORONTO (Reuters) – The Bank of Canada (BoC) is expected to lower interest rates quicker than the U.S. Federal Reserve due to weak Canadian growth risking a sustained drop in inflation below the 2% target.

The BoC's neutral interest rate, where the policy rate stabilizes the economy, ranges from 2.25% to 3.25%, with an average of 2.75%. The Federal Reserve's estimate is similar at 2.9%.

Moving faster to the neutral rate could relieve the burden on heavily indebted Canadians and may negatively impact the Canadian dollar, which hit a two-month low at 1.3783 per U.S. dollar, or 72.55 U.S. cents.

Andrew Kelvin of TD Securities noted that the BoC has more urgency to reach the neutral rate, as slower Canadian growth implies greater economic slack.

While major central banks are synchronously cutting rates, they differ on the pace and extent of easing cycles necessary to balance inflation and economic growth.

Investors believe the BoC may cut its benchmark interest rate from 4.25% to 2.75% within a year, while uncertainty exists regarding the Fed's potential for similar cuts.

Canada’s economy has been growing slower than the 2.4% pace the BoC considers potential, contributing to cooling inflation down to 2% in August, which the central bank views as undesirable due to extra economic slack.

Recent data indicated Canada added 47,000 jobs in September, surpassing expectations. However, a BoC survey revealed firms are still grappling with weak demand, leaving the odds of a significant half-percentage-point cut at about 50% for the upcoming policy meeting on October 23.

The BoC has been cautious with quarter-percentage-point cuts but may follow the Fed’s approach of larger cuts starting with a 50-basis-point move in September, as the domestic economy faces significant challenges.

Royce Mendes from Desjardins anticipates a 50-basis-point reduction this month, citing expected population growth slowdown and impending mortgage renewals at higher rates.

Mendes highlighted that accelerating towards the neutral-rate range could act as an insurance policy against inflation falling consistently below target.

Investors have noticed the risks of below-target inflation, as breakeven rates for expected inflation have dipped below 2% recently. Adam Button from ForexLive warned that if Canada misses its inflation target, it could lead to significant currency depreciation as the BoC would be likely to cut rates while the U.S. does not face similar pressures.