Bank of Canada Cuts Interest Rates Amid Economic Uncertainties

TORONTO — The Bank of Canada announced a reduction in its target for the overnight rate to 4½%, with the Bank Rate set at 4¾% and the deposit rate also at 4½%. This move marks a continuation of the Bank’s policy of balance sheet normalization and comes amid a complex economic landscape both domestically and internationally.

Global and Domestic Economic Outlook

Globally, the economy is projected to expand at an annual rate of about 3% through 2026. Inflation remains above target levels in many advanced economies but is expected to ease gradually. In the United States, a slowdown in economic activity is becoming evident, with moderated consumption growth and signs of inflation declining. The euro area is experiencing a recovery following a sluggish 2023, while China is seeing modest growth, driven by strong exports despite weak domestic demand. Global financial conditions have generally eased, with lower bond yields, strong equity prices, and robust corporate debt issuance.

In Canada, the economy grew at an estimated rate of 1½% in the first half of 2024. However, with population growth at around 3%, the country’s potential output is rising faster than GDP, leading to increased excess supply. Household spending, including consumer purchases and housing, has been notably weak. The labour market is also showing signs of slack, with the unemployment rate increasing to 6.4%. Employment growth is lagging behind the expansion of the labour force, with job seekers taking longer to find work. While wage growth shows some signs of moderation, it remains elevated.

Future Economic Projections

The Bank of Canada forecasts GDP growth to pick up in the latter half of 2024 and continue through 2025, buoyed by stronger exports and a recovery in household spending and business investment as borrowing costs ease. Residential investment is expected to grow robustly. New government limits on the admission of non-permanent residents are projected to slow population growth in 2025, potentially easing some pressure on the housing market and labour supply.

For the years ahead, the Bank predicts GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. This growth is expected to gradually absorb the existing excess supply in the economy, aligning economic output with potential output by 2026.

Inflation Trends and Policy Response

CPI inflation moderated to 2.7% in June, following a rise in May. The Bank’s core inflation measures have stayed below 3% for several months, with broad inflationary pressures easing. However, shelter price inflation remains a significant driver, influenced by high rent and mortgage interest costs. Inflation is also high in services sectors closely tied to wage costs, such as restaurants and personal care.

The Bank expects core inflation to decelerate to around 2½% in the second half of 2024 and to continue easing through 2025. CPI inflation is anticipated to dip below core inflation in the latter half of this year, primarily due to base year effects on gasoline prices. However, it may edge up again before stabilizing around the 2% target in the following year.

Governing Council’s Decision and Future Outlook

The Governing Council’s decision to reduce the policy interest rate by 25 basis points reflects the balance between easing broad price pressures and the persistence of inflation in specific sectors. The Council emphasized that monetary policy decisions would continue to be guided by incoming data and their implications for the inflation outlook. The Bank reaffirmed its commitment to restoring price stability, a critical mandate in the face of current economic challenges.

As Canada navigates these complex economic conditions, the Bank of Canada’s actions will be closely watched by consumers, businesses, and policymakers. The effectiveness of these measures in stabilizing the economy and controlling inflation will be crucial in shaping the country’s economic trajectory in the coming years.