Throughout the various interest rate increases, voices were skeptical about the Bank of Canada’s policy aimed at curbing inflation.
Aren’t we going to kill the economy by trying to control inflation? Are we not sacrificing the younger generation who have become unable to buy a house? Why not exclude mortgages from the rate hike?
Experts even wondered whether the 2% inflation target should not be adjusted. Moreover, it was said, the Bank cannot control inflation which comes in particular from international supply chains.
The Bank of Canada has stayed the course, against all odds. And we must admit today that it won: its repeated increase in the key rate to 5% made it possible to bring inflation down to 2.7%, i.e. within its 1% range. at 3%.
The annual increase in all prices is still too high, at 2.7%, but looking at recent trends, and knowing that interest rates have an impact delayed by several months after being raised, the Bank judges that the time has come to undertake a gradual reduction in its key rate.
Canada thus becomes the first G7 country to relax rates, which is no small thing.
“If inflation continues to slow and the data continues to reinforce our confidence that it is heading towards the 2% target, it is reasonable to expect further cuts in the policy rate,” said the governor, Tiff Macklem.
Okay, the Bank’s stubbornness has slowed the economy considerably. But for the moment, Canada has not fallen into recession, its economy rather seems to be heading towards a soft landing, as Tiff Macklem says.
Above all, the ultimate mission of the Bank of Canada has never been to prevent a recession or to account for unemployment, but to seek to “keep inflation at a low, stable and predictable level”, which constitutes the best long-term tool to “promote Canada’s economic and financial prosperity1 “.
It was a hard pill to swallow. And it still is for many Canadians who have lost their jobs or seen their mortgage payments increase.
Another effect of monetary policy: it was one of the factors which contributed to the rise of the Conservative Party. Its leader Pierre Poilievre repeated that Prime Minister Justin Trudeau was responsible for inflation (“Justinflation”) and blamed him for the rise in interest rates.
This oft-repeated information had effects, even if Prime Minister Trudeau and the politicians had nothing to do with setting base interest rates, given the independence of the Bank of Canada.
Moreover, other central banks around the world used the same remedy at the time of COVID-19 and after, with similar effects on the economy.
And now ? Most economists expect the Bank to continue to lower its key rate substantially.
Desjardins Group forecasts a reduction of another 75 basis points by the end of 2024, which would reduce the key rate from 5% to 4%. Same prediction from Sébastien Mc Mahon, chief strategist of Industrial Alliance, while the National Bank is counting on an additional drop of 50 basis points.
Desjardins even expects a drop of 250 points by the start of 2026, which would increase the key rate to 2.25%. Wow!
Variable and short-term (one year) mortgage rates should follow the same downward trend, which will provide relief to many borrowers. On the other hand, long-term rates, for example 5 years, should not decrease as much, being influenced by other factors.
The rate cuts will relieve some consumers, but will make Canadian tourists who go to the United States smile less. Because at the same time, the key rate of the American Federal Reserve should not decrease to the same extent by the end of 2024, given the resilience of inflation, which will have the effect of putting pressure on the loonie, predict the most economists.
The gap between the Bank of Canada rate and that of the FED could even reach 100 basis points at the end of 2024, estimate Desjardins and Industrial Alliance. The gap could push the loonie down by 3 cents, to 70 US cents, estimates Mr. Mc Mahon of Industrial Alliance.
The National Bank also anticipates a drop of around 3 cents by the end of 2024, to around 70 cents, but attributes this drop to the two-year bond yield gap in the two countries, which will widen, according to its economists. (4.5% in the United States versus 3.5% in Canada).
In short, some economic upheavals in sight, but if the Canadian economy is not hit too hard by the slowdown that is emerging in the United States, it will be for the best… Phew!
1. At most, in the Bank’s 2021 renewed mandate, it is stated that “the Government and the Bank agree that given the need to properly anchor inflation expectations to achieve both the price stability and the maximum sustainable level of employment, the primary objective of monetary policy is to keep inflation low and stable over time.
Consult the Renewal of the Bank of Canada’s monetary policy framework