Economists and market watchers are predicting the Bank of Canada will cut interest rates again this week as evidence mounts of a sustained slowdown in inflation.
Expectations that the bank will cut its key rate when it makes its scheduled announcement Wednesday have been high since the release of Statistics Canada’s latest inflation report last week, which showed annual inflation cooled to 2.7 per cent in June.
The inflation rate was lower than the 2.8 per cent that markets had expected. That helped boost market confidence that the Bank of Canada may be ready to announce a second rate cut, on top of the 25 basis point reduction announced last month.
“I think it’s very likely that the Bank of Canada will cut rates again next week. It wouldn’t really make sense, from a policy perspective, to cut rates by just 25 basis points and then leave them there and see how the economy responds. It wouldn’t really cause much change in the trajectory of the economy or inflation,” said Royce Mendes, managing director and head of macroeconomic strategy at Desjardins.
“So it has always made sense for the Bank of Canada to deliver at least two rate cuts in a row before pausing. And now recent data reinforces that view,” he continued.
Last month’s interest rate cut, which lowered the central bank’s key rate from 5 percent to 4.75 percent, was the first in more than four years.
Slight increase in unemployment rate
In addition to the latest inflation report, recent data showing rising unemployment as well as subdued growth expectations from Canadian businesses all support the prospect of further reduction, Mendes continued.
Although inflation remains above the Bank of Canada’s 2% target, Mendes said a longer delay could have negative repercussions.
“Interest rates at the levels they are [actuellement] are actually very restrictive. You can see that in consumer spending trends. You can see that in the housing market,” he illustrated.
“I would say that if [la Banque du Canada] If the Fed did not cut rates next week, it would signal a much greater willingness to tip the economy into recession, just to bring down inflation by a few more tenths of a percentage point.”
Statistics Canada’s latest retail sales report on Friday showed Canadians cut back on spending in May, with retail sales falling 0.8 per cent to $66.1 billion.
Sales fell in eight of the nine subsectors it tracks, the agency said.
“What the Bank of Canada is trying to do is simply reduce the restrictions that they’re putting on the economy. They’re not trying to stimulate the economy, they’re simply trying to reduce the headwinds that they’re creating,” Mendes said, adding that a second rate cut could make Canadian consumers feel more confident about spending again.
The latest data on Canada’s labour market shows the economy stagnated in June, losing 1,400 jobs while the unemployment rate rose to 6.4% from 6.2% in May.
The June reading was the highest unemployment rate since January 2022, another indication that increases the chances the Bank of Canada will cut rates this week.
Limited impact
But while most market watchers believe an interest rate cut will come this week and be followed by further cuts later in the year, that view is not unanimous.
Clay Jarvis, a mortgage and real estate expert at NerdWallet Canada, believes this week’s decision could go either way.
“Given the bank’s caution, cutting the funding rate while inflation is still well above 2% would be quite unusual,” he said in a note.
If the cut does occur, a 25 basis point reduction in variable interest rates is unlikely to be enough to significantly shake up the Canadian housing market, Jarvis added, as buyers grapple with the prospect of higher mortgage payments.
A survey conducted by CPA Canada (an organization representing professional accountants) and BDO Debt Solutions shortly after the June rate cut found that half of Canadians say interest rate hikes have had a negative impact on their debt levels, with seven in 10 saying the June rate cut had no impact on their financial outlook.
The survey also found that 52% of respondents believe that further interest rate cuts will not be enough to reduce financial stress.