Bank of Canada cuts interest rate, signals more to come if inflation keeps dropping

Canada's central bank expected to cut rates CTV News' Scott Hurst has the latest on the new affordability numbers for purchasing a home in most major cities.

The Bank of Canada has decreased its policy interest rate for the second consecutive time and signalled more cuts are coming if inflation continues to ease.

The 25 basis points reduction brings the overnight rate to 4.5 per cent, returning to levels not seen since June 2023. Last month’s cut from 5 per cent to 4.75 per cent was the first in more than four years.

Bank of Canada Governor Tiff Macklem said the decision was based on economic data showing slack in the labour market, excess supply in the economy and inflation continuing to drop.

“We are increasingly confident that the ingredients to bring inflation back to target are in place,” Macklem said in his opening remarks.

Since the Bank of Canada started raising rates in March 2022 inflation has dropped from a peak of 8.1 per cent in June 2022 to 2.7 per cent in June 2024, after a slight increase in May.

“Looking ahead, we expect inflation to moderate further, though progress over the next year will likely be uneven,” Macklem said.

If inflation continues to ease as expected, Macklem signalled Canadians can expect more rate cuts. Those decisions, he said, will be taken one decision at a time.

“If inflation continues to ease broadly in line with our forecast, it is reasonable to expect further cuts in our policy interest rate,” Macklem said. “The timing will depend on how we see these opposing forces place out.”

Many economists and big banks expect the bank could cut rates as many as four times by the end of 2024. The speed of those cuts will likely depend on how quickly peers at the Bank of England and the United States Federal Reserve cut rates. Last month, the Bank of Canada became the first Group of Seven central banks to do so since the pandemic began.

The central bank expects broad inflationary pressures to continue easing, with the bank’s preferred measures of core inflation now consistently below 3 per cent and expected to slow to about 2.5 per cent in the second half of 2024.

In its Monetary Policy Report the central bank highlights concerns that inflation is being held up by high shelter costs, driven by rent and mortgage interest costs, as well as by services that are closely affected by wages, such as restaurants and personal care. While few details were provided, the monetary report warns that “housing market imbalances” will continue to put upward pressure on inflation throughout much of the projected horizon.

“We are carefully assessing the downward pull on inflation from ongoing excess supply, and the pressures from shelter and other services that are holding inflation up,” Macklem said. “Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook.”

There are three more interest rate decisions this year, with the next scheduled for Sept. 4. When asked whether Canadians can expect three more rate cuts before the end of 2024, Macklem said the bank is not on a “pre-determined path.”

“Our forecast has inflation declining gradually,” he said, adding it won’t be a straight line back to target. “It is reasonable to expect further cuts, but the timing is going to depend on incoming data and importantly what that data tells us about where inflation is headed.”

Macklem said the expected direction of its policy rate is lower, but stressed that those decisions depend on what the economic data is telling the bank about where inflation is heading.

“We are determined to get inflation back to 2 per cent, but we also don’t want to weaken the economy too much and have inflation go below our 2 per cent target,” he said.

How is the Canadian economy looking?

After having stalled in the second half of 2023, gross domestic product (GDP) expanded by roughly 1.75 per cent in the first quarter of 2024, driven by strong population growth.

The central bank predicts economic growth will continue to increase in the second half of 2024 as interest rates ease and household and business confidence rise. Due to what the bank expects will be slower population growth, GDP growth is projected to be about 2.1 per cent in 2025 and 2.4 per cent in 2026.

As GDP grows, the central bank expects core inflation to ease to about 2.5 per cent in the second half of 2024 and, due to a temporary decline in gasoline prices, it expects consumer price index (CPI) inflation to come down below core inflation during the same time frame. The bank, however, does warn that getting to target will be “bumpy” in the short term, with CPI inflation expected to rise slightly in the first half of 2025 before settling again at 2 per cent in the second half of 2025.

Consumption per person is expected to grow, though the bank says there is much uncertainty here given some mortgage holders will have to renew at a higher interest rate, and some variable-rate mortgage holders with fixed payments will have to deal with higher principle payments once they re-amortize.

What are the risks to the bank’s inflation outlook?

Among the biggest factors that could hold up inflation are global geopolitical developments, such as new international trade disruptions stemming from global conflicts like the wars in the Middle East and Ukraine.

The bank says those conflicts could impact commodity prices and impede the supply of traded goods. If global shipping routes are attacked, the bank says producer costs could increase and the return to the inflation target delayed.

Another major concern is shelter price inflation, which right now sits above its historical average around 7 per cent. The bank fears shelter prices could remain high for longer than expected, in part because stronger-than-usual population growth and a shortage of houses is keeping vacancy rates at record lows.

As the central bank nears its 2 per cent inflation target, Macklem says it is increasingly important to understand the downside and upside scenarios that impact its movement.

“The message is we have made a lot of progress,” Macklem said. “We are getting back into a much more normal zone.”

Impact of immigration

The bank’s latest monetary policy report includes a section about the impact of newcomers on the Canadian economy, especially on the housing market and shelter inflation.

Over the past two years, Canada’s population has grown by 6 per cent, almost all of which is due to the arrival of newcomers. During this time the bank says GDP per capita has been soft, largely held up by population growth.

The central bank says newcomers have provided a boost to consumer spending and have significantly boosted the economy’s potential for non-inflationary growth, adding an estimated 2.5 per cent to the level of potential output.

However, the bank says the overall impact of newcomers to the labour market may be lower than expected as many newcomers have faced significant challenges finding jobs.

When it comes to housing, the central bank says strong population growth has boosted demand for housing, adding existing pressures to rent and house prices. While the increase in demand from newcomers is being felt across the sector, the bank says the greatest impact tends to be in rental markets.

'Breathing room for homeowners'

Wednesday's interest rate reduction is good news for anyone borrowing money and for many homeowners. According to Ratesdotca, for every 25-basis-point drop a homeowner with a variable-rate mortgage can expect to pay approximately $15 less per $100,000 of mortgage in monthly payments.

“Combined with the rate cut in June, this decrease will provide a bit more breathing room for homeowners with floating variable-rate mortgages,” says Victor Tran, Ratesdotca mortgage and real estate expert. “However, in terms of the broader housing market, this rate cut isn’t likely to spur much activity. For many, budgets are still too tight and buyers are willing to wait.”

Tran says that a significant uptick in sales activity will only been seen if the central bank cuts by another 25 to 50 basis points.

While Wednesday's change alone may not have a significant impact on the housing market, real estate experts say that it will give buyers and sellers confidence that the economy is moving in the right direction.

“A second cut to the overnight lending rate indicates just that, and with mortgage qualification thresholds continuing to come down, sidelined buyers may have the confidence they need to make their return to the housing market," said Karen Yolevski, COO of Royal LePage Real Estate Services Ltd.