Easing Inflation Triggers 50 bps Rate Cut: What’s Next for the Canadian Economy?

On October 23rd, the Bank of Canada announced a 50 basis point rate cut, reducing its target rate from 4.25% to 3.75%. Historically, such significant cuts have been implemented during times of economic crises, like the 2008 financial downturn and the 2020 pandemic, where the central bank sought to stabilize the economy amid severe shocks. Today’s adjustment, however, is a response to recent data indicating a sharper-than-expected slowdown in inflation, aiming to sustain economic momentum in a period of easing policy. While the current rate of 3.75% is higher than the historically low levels seen during the pandemic response, it remains significantly below the peaks observed in the 1980s and 1990s, as seen in the graph below.

The decision for the 50 bps cut was driven by recent GDP and inflation data. Specifically, inflation slowed to 1.6% in September—significantly lower than the Bank's earlier expectations. In the September 4th announcement, the Bank of Canada projected that inflation would not reach its 2% target until the second half of 2025. This unexpected slowdown is attributed to factors such as excess supply, a decline in global oil prices, and muted inflation expectations.

Parallel to the declining inflation and interest rates, September saw a significant shift in the yield curve, normalizing for the first time since July 2022. Long-term yields rose above short-term yields, a typical structure that reflects an optimistic economic outlook. This suggests that market participants perceive reduced short-term risks and have greater confidence in the economy’s ability to stabilize and expand.

Source: Bank of Canada - Selected Bond Yields

During the press conference, Governor Tiff Macklem provided further insights into the outlook for Canada’s economy. He signaled that further rate cuts are likely as the Bank aims to maintain inflation within its 1-3% target range. Macklem also emphasized that there will be no changes to the quantitative tightening policy at this time, with the GDP growth forecast for 2024 holding steady at 1.2%.

Even with these positive signs, several risks could slow the recovery. The Bank of Canada’s forecast assumes that a 50 bps rate cut will stimulate household spending, business investment, and a recovery in housing activity. If these effects take longer to materialize, the economic recovery could face delays. Recent surveys show that businesses currently have modest hiring and investment plans, suggesting a slower response to the easing measures. Currently the World Interest Rate Probability indicates that market participants anticipate another 50 bps rate cut in December.

World Interest Rate Probability (source: Bloomberg) October 23rd, 2024

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