For the financial markets, the cause is understood, the probability of a first cut in the Bank of Canada’s key rate this Wednesday is more than 80%. Furthermore, more and more economists who closely follow monetary policy are leaning towards a first cut in the key rate from 5% to 4.75% this Wednesday, rather than the next decision scheduled for July 24.
What will the Bank of Canada do?
“There is no advantage to waiting six more weeks,” says Dominique Lapointe, director of macroeconomic strategy at Manulife.
“By July, the risk of a rise in inflation is quite low,” he believes. Likewise, economic growth is unlikely to accelerate again in the next six weeks. »
In the end, it’s a question of judgment, says Jimmy Jean, chief economist at Desjardins. “Central bank leaders have all the data imaginable to make a decision. Ultimately, it comes down to the weight we give to different data because we never have perfect information. »
Like Dominique Lapointe, Jimmy Jean expects a reduction in the key rate this Wednesday, the first since March 2020, when the pandemic paralyzed the economy. The Bank of Canada’s key rate has been at 5%, its highest level in 20 years, since July 2023.
The Governor of the Bank of Canada, Tiff Macklem, has already said that everything is in place for an upcoming reduction in the key rate but that a few months would be necessary to ensure that inflation is indeed brought under control.
Waiting until July could increase the Bank of Canada’s degree of confidence in the positive trends that have been emerging for several months already, believes Matthieu Arseneau, economist at the National Bank. “By July 25 (the date of the next rate decision), there will be two more reports on inflation, another on employment and new data on the evolution of the economy,” says -he.
National Bank Financial expects the Bank of Canada to maintain its key rate at 5% this Wednesday, even if “everything is there to justify a reduction,” estimates the economist.
The central bank wants to avoid at all costs having to turn around after lowering its key rate, because inflation is reappearing. But waiting also increases the risk that the economy falls into recession and requires emergency rate cuts, which would be the worst-case scenario, summarize economists interviewed by The Press.
There are arguments on both sides of the equation:
A drop this Wednesday
Weak economy
The Canadian economy is on the verge of recession, which increases pressure on the central bank not to wait before lowering its key rate. In the first quarter of 2024, gross domestic product grew at an annualized rate of 1.7%, while an increase of 2.2% was expected. Worse, GDP growth for the final quarter of 2023 was revised downward from 1.0% to 0.1%, despite a significant population increase supporting the economy.
Decline in inflation
The level of inflation measured by the Consumer Price Index has returned to within the Bank of Canada’s target of 1 to 3%. The most recent CPI reading, from April, was 2.7%. Housing prices remain sharply rising, but excluding the cost of mortgage interest, which would be relieved by lower interest rates, the overall inflation rate has fallen below 2%. All core inflation measures that the central bank monitors have also fallen below the 3% threshold.
Unemployment on the rise
The number of vacant positions is clearly decreasing. The increase in population also contributes to cooling the labor market. The rise in the unemployment rate is also starting to have an impact on wages, the increase in which worried the Bank of Canada and which has slowed down. The figures for the month of May will be released by Statistics Canada on Friday, after Wednesday’s decision on the rate. Most economists predict that the job market will continue to deteriorate.
A drop in July
Report the decline first
The Bank of Canada has a habit of telegraphing its intentions in advance, so as not to surprise the markets. This is what it did in 2022, before increasing its key rate which was then at the floor. The inflation rate continued to rise until her next decision, and many observers concluded that she waited too long before beginning monetary tightening. This time, the central bank could simply indicate clearly on Wednesday that it will lower rates at its next decision, in July.
The price of houses
Spring is generally a very active season on the real estate market. A cut in the key rate in June, even by just 25 basis points, could be enough to excite a market repressed by high interest rates and which is just waiting for a signal to come back to life. Home prices could rise quickly and fuel housing-related inflation, which may prompt the Bank of Canada to wait longer to begin cutting rates.
The Federal Reserve’s brake
The fact that the decline in interest rates in the United States is becoming more distant is another factor that encourages the Bank of Canada to take its time. The Canadian economy can live with lower interest rates than in the United States, but the risk of a fall in the dollar which would increase the price of all imported products and revive inflation is a brake on the decline in rates in Canada. If the Federal Reserve had already lowered its key rate, the Bank of Canada would probably have already done so, believe several economists.