The Bank of Canada is expected to cut interest rates by a quarter of a percentage point for a third straight time on Wednesday, and by then it will still be far from done with its rate cuts.
This would bring its key rate from 4.5% to 4.25%, after two initial reductions in June and July.
Faced with an unexpected but sustained surge in inflation in the wake of the COVID-19 pandemic, central banks around the world responded with equally aggressive interest rate hikes to dampen consumer and business demand for goods and services. The Bank of Canada was no exception, raising its main policy tool rate from 0.25% to 5% from March 2022 to July 2023.
This drag on economic growth and demand has finally had an effect, with inflation as measured by annual growth in the consumer price index falling from its last peak of 8.1% in June 2022 to its lowest level in more than three years of 2.5% last July. This is now the seventh consecutive month that inflation has remained within the Canadian central bank’s target range of 1% to 3%.
Unemployment and Mortgages
Meanwhile, economic activity and employment levels appear increasingly sluggish, especially when we take into account the strong population growth with immigration. The unemployment rate in Canada has thus risen from 5% at the beginning of 2023 to 6.4% this summer. It is at the point where, at her last interest rate increase, Bank of Canada Governor Tiff Macklem said that it was now necessary for “growth to pick up so that inflation does not fall too much.”
What’s more, his institution knows only too well that many Canadian households will still have to renew their mortgages in the coming months and that almost all of them will do so at a much higher interest rate than the one they were granted a few years ago. Now that its battle against inflation has been won, and for all intents and purposes won, lowering its key rate is “the best way to avoid unnecessary difficulties related to [à ces] mortgage renewals,” said Royce Mendes, economist at Mouvement Desjardins, on Friday.
Markets are thus predicting that the Bank will cut its interest rates by a quarter of a percentage point in each of its two remaining announcements this year, which would take its key rate to 3.75%. Many observers predict that it will continue its momentum to reach 3% within a year.
The sooner the better if the damage to growth and living standards is to be reduced, say some experts, who are calling for cuts of 0.5 percentage points rather than just 0.25%. Especially since the Bank itself estimates that each of its changes takes between 18 and 24 months to have its full effect on the economy.