The Bank of Canada lowered its benchmark interest rate for the second consecutive time on Wednesday in a dovish rate announcement that put new emphasis on downside risks to economic growth and teed up additional rate cuts this year.
The widely anticipated move brings the bank’s policy rate to 4.5 per cent from 4.75 per cent. It’s the second step in a long-awaited easing cycle that is slowly normalizing borrowing and debt-servicing costs for Canadians after the historic run-up in interest rates in 2022 and 2023.
Inflation has slowed considerably over the past two years, as global supply chains have improved, economic growth has stalled and restrictive interest rates have curbed consumer spending. With central bankers increasingly confident that inflation is on the right path down, they’re starting to worry about overshooting the mark, and jeopardizing a soft-landing for the economy.
“As inflation gets closer to the 2-per-cent target, the risk that inflation comes in higher than expected has to be increasingly balanced against the risk that the economy and inflation could be weaker than expected,” Bank of Canada Governor Tiff Macklem said in a news conference after the announcement.
He said it’s “reasonable” to expect more rate cuts if inflation continues trending lower, as the central bank is forecasting. But the bank’s governing council will be taking each decision at a time, he said: “The expected direction of our policy rate is lower, but we’re not on a predetermined path.”
Interest rate swap markets, which capture private-sector expectations about monetary policy, now put the odds of another rate cut in September at slightly above 50 per cent, according to LSEG Data & Analytics – several ticks higher than before the announcement. Financial markets expect two more cuts before the end of the year, which would bring the policy rate to 4 per cent.
“Governing council didn’t provide any explicit guidance about what comes next, but there’s a strong sense that policy makers feel an urgency to continue the rate-cutting cycle,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients.
“The dovish language in the release paints a picture of officials who are growing more worried about the likelihood of recession. As a result, we are pulling forward our rate-cut expectations to forecast another move in September.”
The bank’s focus on downside risks to economic growth and inflation is new, at least within this economic cycle. Starting in the spring of 2022, Mr. Macklem and his team have been actively trying to slow down the Canadian economy, hammering consumers and businesses with 10 interest rate increases in 2022 and 2023 in an effort to constrain consumer spending and bring inflation to heel.
Restrictive monetary policy has taken a toll. Economic growth has slowed to a crawl, consumer and business sentiment is in the dumps and the unemployment rate has risen to 6.4 per cent from 4.8 per cent two years ago. The economy has avoided an outright recession owing to rapid population growth. But GDP per capita has declined for the past year-and-a-half.
That’s opened considerable slack in the economy, and Mr. Macklem and his team are starting to talk about the need to kick-start economic growth, rather than restrain it.
“We need job creation to start picking up to absorb the excess supply in the economy and get inflation sustainably back to target,” he said.
This shift is only possible because price increases on a broad range of goods and services are slowing down. After reaching a four-decade high of 8.1 per cent in 2022, the annual inflation rate has been back below 3 per cent since the start of the year, hitting 2.7 per cent in June.
Pockets of inflationary pressure remain. Rent continues to rise quickly and homeowners are experiencing huge jumps in monthly interest payments when they renew their mortgages – a direct result of past rate hikes by the central bank. Likewise, prices are rising quickly for some services that are highly sensitive to labour costs.
But the bank is “increasingly confident that the ingredients to bring inflation back to target are in place,” Mr. Macklem said, while acknowledging that “there could be setbacks along the way.”
The bank’s new forecast in its quarterly Monetary Policy Report sees inflation falling below 2.5 per cent in the second half of the year and settling “sustainably” at 2 per cent next year.
The report also projects economic growth will pick up over the second half of the year and into next year, led by an increase in oil exports through the Trans Mountain Pipeline, a rise in business investment and stronger consumer spending as debt-servicing costs ease. But there are downside risks, especially if the wave of mortgage renewals expected over the next two years bites harder than expected. The bank expects annual GDP growth to total 1.2 per cent this year, before rising to 2.1 per cent in 2025 and 2.4 per cent in 2026.
“The statement highlighted a pickup in economic growth ahead, but note that lower interest rates are cited as a driver of that growth, so there is clearly an intention to continue to trim rates this year and in 2025,” Canadian Imperial Bank of Commerce economists Avery Shenfeld and Andrew Grantham wrote in a note to clients.
Wednesday’s rate cut is welcome news for homeowners with variable rate mortgages, whose interest rates track changes in the central bank’s policy rate. It will have less of an impact on fixed-rate mortgages, which are based on bond yields that have already adjusted in anticipation of central bank rate cuts.
Analysts don’t expect a second cut by itself will spark a rebound in real estate sales or a major run-up in home prices. Mortgage rates are still prohibitively high for many new home buyers, and other market participants remain on the sidelines waiting for more moves by the central bank.
When it comes to housing affordability, for both homeowners and renters, two rate cuts aren’t a game-changer. But a downward trend in interest rates could help over the longer term, according to Adam Jacobs, head of research for real estate company Colliers Canada.
“The issue right now is just there’s not any housing getting built because rates are so high, it’s kind of impossible to make the math work, and at the same time, we have record high population growth,” Mr. Jacobs said in an interview.
A pair of rate cuts is “not doing anything right now to make rents go down. But if you take the longer-term view, this will allow us to build more apartments, make more residential projects feasible, get construction going again. And that’s probably what’s needed, more than your monthly mortgage coming down $100 or something like that.”
Bank of Canada senior deputy governor Carolyn Rogers said in the press conference that Canada’s housing affordability problems won’t be solved by interest rate cuts alone. Housing has been expensive in both low- and high-interest rate environments, and the root cause is a “structural imbalance” between the supply and demand for homes, she said.
“The bottom line on housing is we are going to lower interest rates if the economy continues to go in the direction that we expect. That will have some effect, that will help on housing,” she said.
“But it isn’t the magic solution. It would be a mistake to pin all of our hopes on our housing imbalance on interest rates. Canadians need a more fulsome, more co-ordinated policy response than that.”
The Bank of Canada held a news conference to announce its decision to lower its policy interest rate by a quarter of a percentage point. It marked the second consecutive time the central bank cut its key interest rate in the face of slowing inflation and weakening economic conditions.
The Canadian Press
