The Bank of Canada made a significant move by cutting its key interest rate by 25 basis points to 4.25%, marking the third consecutive reduction in an effort to support economic recovery. Since the beginning of the easing cycle in June, the rate has fallen 75 basis points. A similar streak of consecutive interest rate cuts was last seen during the global financial crisis in 2009.
The key (or policy) interest rate directly impacts borrowing costs and has influence on mortgages and other loans. A lower rate makes it cheaper to borrow, encourages spending and investment, but also reduces incentives to save.
Governor of the Bank of Canada, Tiff Macklem, has indicated that further rate cuts may be on the horizon if the economy continues to show signs of improvement. The Canadian economy grew by 2.1% in the second quarter of 2024 due to government spending and business investment, surpassing the central bank’s July forecast. Compared to the near zero growth in 2023, this is a promising step forward.
Macklem noted that the central bank expects steady growth in the second half of 2024, with inflation gradually easing. However, achieving the 2% inflation target remains difficult, especially due to challenges in the housing market. Although the easing has lowered interest rates, it has not been enough to make a significant difference when it comes to mortgages. Macklem has said that housing and shelter accounts for 25% of the average Canadian consumers’ spending basket.
While the Bank of Canada is close to reaching its target rate with the annual inflation rate dropping to 2.5% in July, concerns are growing that excessive easing could lead to deflation. Falling below the target is as problematic as exceeding it. As Macklem stated, “With inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much.” The Bank must take calculated steps to get the rate to be stable and predictable so that the economy can prosper.
At the same time, the labour market has shown signs of weakness, with unemployment rising to 6.4% in June and holding steady in July. It has been noticed that much of the unemployment is amongst youth and newcomers to Canada. Since wage growth is relative to a productive economy, a slowdown in the labour market also leaves an air of uncertainty in regards to wage growth.
Perhaps more clarity will come on October 23, when the Bank of Canada will make its next interest rate announcement and updated economic forecast.
