Bank of Canada Lowers Interest Rates to 4.5%, Signals Further Easing

The Bank of Canada has lowered interest rates by a quarter percentage point for the second consecutive meeting and signaled further easing ahead as inflation concerns diminish. On Wednesday, Governor Tiff Macklem and his team reduced the benchmark overnight rate to 4.5%. This move was widely anticipated by markets and economists in a Bloomberg survey. Officials expect continued below-potential growth to help cool inflation and are increasingly focusing on economic challenges.

Increased Focus on Economic Headwinds

“With our target nearing and more excess capacity in the economy, downside risks are gaining prominence in our monetary policy discussions,” Macklem stated in prepared remarks. Following the announcement, the Canadian dollar fell to C$1.38 per US dollar, the lowest level since April 19. Short-term bonds rallied, pushing the two-year Canadian benchmark yield down to 3.61%, its lowest since May 2023.

Macklem reiterated that further rate cuts are “reasonable” to anticipate. He emphasized that the bank would make decisions “one at a time,” countering expectations of a predetermined path for rate reductions. Officials noted continued progress in controlling price pressures, aiming for a 2% inflation target that they see “within reach.” The June consumer price index showed inflation slowing to a 2.7% annual rate, indicating diminishing underlying price pressures, according to the bank.

Confidence in Controlling Inflation

Overall, policymakers appear more confident that inflationary pressures are under control. They are now focusing on ensuring a soft economic landing. The dovish tone of their communications suggests that the governing council is prioritizing the prevention of a significant undershoot of the 2% inflation target.

This represents a significant shift in the bank’s stance on inflation. The summary from the officials’ June meeting indicated that they debated whether they needed more evidence of disinflation before easing. Now, there is greater confidence that sufficient evidence exists. “When they start to cut, they tend to do so in clusters,” said David Burrows. Chief investment officer of Barometer Capital Management Inc., on BNN Bloomberg Television. “This is typical, and it’s clearly time.”

OECD Report Highlights Modest Rise in Unemployment, Steady Wage Growth

OECD report highlights a marginal uptick in unemployment rates among wealthy nations in the near term, alongside sustained growth in real wages amidst a slowdown in profit expansion.

Changing Risk Landscape

The balance of risks is also changing. Officials identified weaker-than-expected household spending as a major downside risk, with upcoming mortgage renewals potentially impacting consumption growth. The bank’s statement noted increasing “signs of slack” in the labor market, with job-seekers taking longer to find employment. The Bank of Canada was the first among the Group of Seven central banks to cut rates in June, followed by the European Central Bank. Increasingly, markets and economists believe the Federal Reserve will also begin easing.

“All in all, the Bank of Canada is signaling that ‘further cuts are reasonable’ if disinflation continues. “We now see this as the ‘default’ position—cutting rates barring any major inflation surprises”. Said Dominique Lapointe, director of macro strategy at Manulife. “Given the narrow path to achieving a soft landing, we now expect the Bank of Canada to cut rates at every remaining meeting this year. This would bring the overnight rate to 3.75% by December 2024.”

Economic Forecasts and Housing Market Adjustments

In its accompanying monetary policy report, the bank maintained its economic forecasts, expecting growth to remain below potential in the forecast horizon. Inflation is projected to rise 2.6% this year, steadily declining to 2% by the end of 2025. A significant increase in housing prices is no longer considered a primary upside risk. The bank has reduced housing’s contribution to the economy for 2024.

The report also predicts a reacceleration of growth to a 2.8% annualized rate in the third quarter, partly due to higher exports from the expanded Trans Mountain pipeline. The economy is expected to grow by 1.2% in 2024, down from the previous estimate of 1.5%. The bank noted that while wage growth remains high, it is slowing as the labor market loosens. Corporate pricing behavior has largely normalized, and inflation expectations have declined.

Balancing Act in Monetary Policy

The July policy statement shifted focus from previous concerns, highlighting “ongoing excess supply” and “opposing forces” on inflation, particularly in housing and services sectors. The recent increase in the three-month moving average of the bank’s preferred core inflation measures. Which rose to 2.91% in June, was not mentioned. Instead, the focus was on the expected slowdown in the yearly change of median and trim CPI to 2.5% in the third quarter, according to new projections.

A more rapid rate-cutting approach could help policymakers address upcoming mortgage renewals. This would mitigate the payment shock for homeowners who took out loans at historically low rates during the pandemic. However, moving too quickly risks reigniting inflationary pressures or exacerbating issues in the supply-constrained housing market.

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