BoC Cuts Policy Rate 25bp to 4.50%; Prime Follows

The Bank of Canada has announced it has:

reduced its target for the overnight rate to 4½%, with the Bank Rate at 4¾% and the deposit rate at 4½%. The Bank is continuing its policy of balance sheet normalization.

The global economy is expected to continue expanding at an annual rate of about 3% through 2026. While inflation is still above central bank targets in most advanced economies, it is forecast to ease gradually. In the United States, the anticipated economic slowdown is materializing, with consumption growth moderating. US inflation looks to have resumed its downward path. In the euro area, growth is picking up following a weak 2023. China’s economy is growing modestly, with weak domestic demand partially offset by strong exports. Global financial conditions have eased, with lower bond yields, buoyant equity prices, and robust corporate debt issuance. The Canadian dollar has been relatively stable and oil prices are around the levels assumed in April’s Monetary Policy Report (MPR).

In Canada, economic growth likely picked up to about 1½% through the first half of this year. However, with robust population growth of about 3%, the economy’s potential output is still growing faster than GDP, which means excess supply has increased. Household spending, including both consumer purchases and housing, has been weak. There are signs of slack in the labour market. The unemployment rate has risen to 6.4%, with employment continuing to grow more slowly than the labour force and job seekers taking longer to find work. Wage growth is showing some signs of moderating, but remains elevated.

GDP growth is forecast to increase in the second half of 2024 and through 2025. This reflects stronger exports and a recovery in household spending and business investment as borrowing costs ease. Residential investment is expected to grow robustly. With new government limits on admissions of non-permanent residents, population growth should slow in 2025.

Overall, the Bank forecasts GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. The strengthening economy will gradually absorb excess supply through 2025 and into 2026.

CPI inflation moderated to 2.7% in June after increasing in May. Broad inflationary pressures are easing. The Bank’s preferred measures of core inflation have been below 3% for several months and the breadth of price increases across components of the CPI is now near its historical norm. Shelter price inflation remains high, driven by rent and mortgage interest costs, and is still the biggest contributor to total inflation. Inflation is also elevated in services that are closely affected by wages, such as restaurants and personal care.

The Bank’s preferred measures of core inflation are expected to slow to about 2½% in the second half of 2024 and ease gradually through 2025. The Bank expects CPI inflation to come down below core inflation in the second half of this year, largely because of base year effects on gasoline prices. As those effects wear off, CPI inflation may edge up again before settling around the 2% target next year.

With broad price pressures continuing to ease and inflation expected to move closer to 2%, Governing Council decided to reduce the policy interest rate by a further 25 basis points. Ongoing excess supply is lowering inflationary pressures. At the same time, price pressures in some important parts of the economy—notably shelter and some other services—are holding inflation up. Governing Council is carefully assessing these opposing forces on inflation. Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Mark Rendell in the Globe reports:

Interest rate swap markets, which capture private-sector expectations about monetary policy, now put the odds of another rate cut in September at slightly above 50 per cent, according to LSEG Data & Analytics – several ticks higher than before the announcement. Financial markets expect two more cuts before the end of the year, which would bring the policy rate to 4 per cent.

Pockets of inflationary pressure remain. Rent continues to rise quickly and homeowners are experiencing huge jumps in monthly interest payments when they renew their mortgages – a direct result of past rate hikes by the central bank. Likewise, prices are rising quickly for some services that are highly sensitive to labour costs.

But the bank is “increasingly confident that the ingredients to bring inflation back to target are in place,” Mr. Macklem said, while acknowledging that “there could be setbacks along the way.”

The bank’s new forecast in its quarterly Monetary Policy Report sees inflation falling below 2.5 per cent in the second half of the year and settling “sustainably” at 2 per cent next year.

The report also projects economic growth will pick up over the second half of the year and into next year, led by an increase in oil exports through the Trans Mountain Pipeline, a rise in business investment and stronger consumer spending as debt-servicing costs ease. But there are downside risks, especially if the wave of mortgage renewals expected over the next two years bites harder than expected. The bank expects annual GDP growth to total 1.2 per cent this year, before rising to 2.1 per cent in 2025 and 2.4 per cent in 2026.

Bank of Canada senior deputy governor Carolyn Rogers said in the press conference that Canada’s housing affordability problems won’t be solved by interest rate cuts alone. Housing has been expensive in both low- and high-interest rate environments, and the root cause is a “structural imbalance” between the supply and demand for homes, she said.

“The bottom line on housing is we are going to lower interest rates if the economy continues to go in the direction that we expect. That will have some effect, that will help on housing,” she said.

“But it isn’t the magic solution. It would be a mistake to pin all of our hopes on our housing imbalance on interest rates. Canadians need a more fulsome, more co-ordinated policy response than that.”

Prime followed:

Well, Rob Carrick and Ryan Siever will be mad – nothing on the way up and precious few hopes for the way down:

There’s a case to be made for banks giving borrowers a break when what is expected to be the biggest interest rate hike in 22 years is announced on Wednesday.

A brief flashback to 2015 is required to get the sense of this story. The economy back then was in the opposite shape of what it is now – weak enough to prompt the Bank of Canada to cut its trendsetting overnight rate by 0.25 of a percentage point in January and again in July.

The big banks hijacked part of that rate cut. While the overnight rate fell by a total 0.5 of a point, the banks cut their prime rate by cumulative 0.3 of a point. They held back the rest of the rate cut to build their revenues and profit.

There was a delay in reducing the prime when the Canada Overnight rate dropped 25bp to 0.75% in January 2015 and again when Canada Overnight dropped a further 25bp to 0.50% in July of that year.

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