The Bank of Canada announced Wednesday that it is lowering its key rate by 0.5 percentage points to 3.75%. This is the fourth and largest consecutive drop in the cost of money in Canada since June and responds to the lack of strength in the economy and the faster-than-expected drop in inflation.
Still at 5% at the end of spring, the key rate of the Canadian central bank had until then only seen reductions of 0.25 percentage points, but this new reduction of half a point was widely anticipated by markets and analysts.
During the last monetary policy decision of the Bank of Canada, its governor, Tiff Macklem, warned that after a massive and brutal increase in interest rates intended to curb household consumption and business investment and thus bringing inflation back to the 2% target, its concern was now to “protect against the risk that the economy and inflation slow down too much”.
“We are making a bigger reduction today because inflation is now back to 2 percent and we want to keep it near target,” the governor said in a preliminary statement Wednesday. Now, he continued, “we want to see growth strengthen.”
We cannot say that the Canadian economy has shown much strength since the start of the rate cuts, the Bank of Canada noted Wednesday in the quarterly update edition. of are Monetary Policy Report. Instead of the acceleration forecast by the bank from an annualized growth rate of 2.1% to 2.8%, it had to settle for a meager 1.5% in the third quarter. We expect a little more momentum during the last three months of the year (2%) for real total growth this year identical to that of last year, of only 1.2%, and which will then place at less sluggish rates of 2.1% in 2025 and 2.3% in 2026.
Employment is not doing very well either, with an unemployment rate of 6.5%. Young people and newcomers are particularly affected.
But it was first and foremost the trend in inflation that convinced the Bank of Canada that a deeper reduction in its interest rates was necessary this time, explained its governor. In July, it was expected to average 2.3% in the third quarter; in reality, it was more like 2%, even rising to 1.6% last month, below the Bank of Canada’s target.
Towards a “neutral” rate
No wonder, in this context, that financial markets and most analysts were already forecasting that the Canadian central bank would accelerate the pace of its interest rate reduction on Wednesday. With a total low of its key rate of 1.25 percentage points, the Bank of Canada stands out among the 10 major economies, observed Wednesday in a brief analysis the chief economist of the Bank of Montreal, Douglas Porter, no another central bank having reduced its own rates by more than 0.75 points.
“If the economy evolves in a manner generally consistent with [nos] forecast, we expect to further reduce the policy rate to support demand and keep inflation on target,” Tiff Macklem said. True to form, he refused to provide any indication of the extent of the upcoming cuts, specifying that each decision was taken at the appropriate time depending on the situation on the ground.
Many observers expect it to immediately return to more modest and usual reductions of 0.25 percentage points. Predicting that economic growth has continued to disappoint, others warn that another drop of 0.5 points in the next and final decision by the Canadian central bank in December is entirely possible.
According to half a dozen experts from the CD Howe Institute’s Monetary Policy Council, its key rate should be 3.5% at the end of the year, and 2.5% in a year.
The Bank of Canada estimates that it usually takes 18 to 24 months for changes in interest rates to have their full effects on the economy. According to her, its key rate is at its “neutral” point when it is in the middle of a range going from 2.25% to 3.25%. Above that, it slows down economic activity; underneath, he stimulates it.
However, we should not make too much of this concept of neutral rate, Tiff Macklem often explains. As the economy constantly swings between cycles of acceleration and slowdown, monetary policy is rarely “neutral,” he says.
The Fed and the loonie
Although its only concern must be the Canadian economy, the Bank of Canada must also take into account the decisions of its American equivalent, recalled Friday the economist at the Bank of Montreal Benjamin Reitze.
After a first cut in its interest rates last month, by which it reduced them by 0.5 percentage points to place them between 4.75% and 5%, the American Federal Reserve may well have to take several pauses in its future monetary easing, the American economy already showing itself to be remarkably vigorous. However, higher interest rates in the United States than in Canada have the effect of weakening the value of the Canadian currency, which favors the country’s exports and reduces the need for the Bank of Canada to relax its monetary policy to stimulate economic activity.
It remains to be seen whether the return of inflation to the Bank of Canada’s target will restore confidence to consumers and businesses who continue to be fearful about the future.
“Inflation and high interest rates have placed a heavy burden on Canadians,” said Tiff Macklem. The return of inflation to target and the continued reduction in interest rates should allow families, businesses and communities to breathe a little easier. »
It is not impossible, notes the central bank, that the drop in interest rates will cause a more vigorous rebound than expected in the housing market. But there is also the risk, conversely, that the Canadian economy will pay the price of “increased geopolitical uncertainty” on the international scene, with, for example, “conflicts in the Middle East and Ukraine, worsening trade tensions and election results in the United States and elsewhere.”
