BoC’s Third Rate Cut: Inflation Control and Economic Growth Under Review

On September 4th, the Bank of Canada announced its third consecutive interest rate cut, lowering the target rate by 25 basis points to 4.25%. While the central bank considered a larger reduction, it opted for a more gradual approach to avoid the risk of overshooting, which could cause inflation to fall below target and potentially weaken the economy. The Bank continues to adjust its policies while closely monitoring the current economic growth and inflationary trends.

Canada’s economy grew by 2.1% in the second quarter of 2024, an increase from 1.8% in the first quarter, driven mainly by government spending and business investment as seen on the graph below. While this growth is encouraging, it remains to be seen if it is sustainable, especially with the recent interest rate cuts aimed at boosting consumer demand. A key focus of the Bank’s policy adjustments has been to lower mortgage costs and stimulate housing demand, though this may prove challenging given that rates, while reduced, remain high compared to pre-pandemic levels.

Factors contributing to the percentage change in real GDP, Q2 2024. Source: Statistics Canada

Inflation is also a central focus for the BoC. In July, the Consumer Price Index (CPI) fell to 2.5% from 2.7%, though shelter costs remain a significant inflationary pressure, with shelter price inflation holding at 3%. The central bank anticipates that inflation will continue to moderate, aiming for the 2% target by the second half of 2025. In the near term, however, inflation might see slight increases as base-year effects fade later in the year.

The labor market has shown signs of strain, with unemployment rising to 6.4% in June and remaining at that level in July, accompanied by a loss of 2,800 jobs. While business layoffs have been moderate, new hiring has been weak, reflecting uncertainties in the economy despite the recent rate cuts.

Although the gap between Canadian and U.S. overnight rates has widened, the Canadian dollar has remained stable against the U.S. dollar. This stability is partly due to the weakening U.S. economy, where job openings have dropped to their lowest level in over three years, and the expectation that the U.S. Federal Reserve will cut interest rates at its September 18 meeting. Investors are anticipating further rate cuts in both Canada and the U.S. in the months ahead, as shown in the WIRP (World Interest Rate Probability) graphs below, which track market expectations for future rate changes.

World Interest Rate Probability (source: Bloomberg) September 4th, 2024

World Interest Rate Probability (source: Bloomberg) September 4th, 2024

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