BoC's Second Rate Cut and Its Implications for the Canadian Economy

On July 24, the Bank of Canada (BoC) announced its second consecutive rate cut, reducing the overnight rate by 25 basis points from 4.75% to 4.5%. This decision comes as CPI inflation stabilized at 2.7% in June, with core inflation consistently staying below 3% for several months. The main drivers of inflation continue to be rising shelter costs and prices for services influenced by wages, such as dining and personal care. At the same time, the labor market is showing signs of slowing, with unemployment increasing to 6.4%.

In the first half of 2024, Canada's economic growth is estimated at 1.5%, with the BoC projecting a 1.2% GDP growth for the entire year, primarily due to weak household spending. However, the BoC expects consumer spending to increase as interest rates decline, becoming a more significant contributor to GDP growth. In contrast, the housing market is expected to play a smaller role, with the Canadian Real Estate Association reporting a 9% year-over-year decline in sales. Further rate cuts may be needed to boost housing demand. Despite slower GDP growth, Canada’s population growth remains robust at 3%. The BoC forecasts GDP growth to rise to 2.1% in 2025 and 2.4% in 2026 as seen on the graph below.

Source: Bank of Canada - Monetary Policy Report (July 2024)

Currently, the U.S. Federal Reserve's target interest rate is 5.50%, resulting in a 100 basis points spread with the BoC rate after the recent cut. There have been three notable instances of significant rate divergences, with two leading to the CAD/USD exchange rate dropping to historical lows of 63 U.S. cents. The sustainable level of the negative spread is estimated to be up to 100 basis points. Bloomberg’s World Interest Rate Probability (WIRP) indicates high probabilities of another rate cut in the next BoC announcement. On the other hand, the Fed, still combating inflation, is likely to start cutting rates closer to the end of the year, possibly beginning in September, with a 97.5% probability. This growing spread is expected to put downward pressure on the CAD, potentially causing further depreciation against the USD.

 World Interest Rate Probability (source: Bloomberg) July 24th, 2024

 World Interest Rate Probability (source: Bloomberg) July 24th, 2024

Despite these challenges, the BoC's economic outlook remains positive. The central bank expects CPI inflation to decrease to 2.4% by the end of the year and further to 2.0% in 2025, aligning with core inflation rates. Real GDP growth is projected to reach 2.0% this year on a year-over-year basis and 2.1% in 2025, indicating a gradual but steady recovery in the Canadian economy.

If you have any questions about today’s Market Update, feel free to call us at 604-643-0101 or email cashgroup@cgf.com .