Economic Indicators Point to a Rate Cut
The economic stars appear to be aligning for the Bank of Canada to deliver an interest rate cut on Wednesday. Financial markets are banking on an 80 percent chance that it will happen. The Bank of Canada has kept its policy rate – the benchmark rate for major Canadian loans like mortgages as well as borrowing costs for businesses and governments – on hold at 5.0 percent since July 2023. Higher interest rates discourage spending and slow growth, which takes away some inflationary fuel out of the economy.
Governor’s Statement and Inflation Trends
Governor Tiff Macklem said at the central bank’s last rate decision in April that an initial cut at the upcoming meeting in June would be “within the realm of possibilities.” That was dependent, he said, on whether inflation and other economic indicators continued to decline according to the Bank of Canada’s expectations. Since that time, inflation has continued to ease. The April reading showed annual inflation had cooled to 2.7 percent from 2.9 percent in March, with the central bank’s preferred metrics of core inflation also showing signs of slowing. This comes despite persistent pressure in shelter inflation pushing up the headline number.
GDP and Labor Market Data
On Friday, Statistics Canada’s latest real gross domestic product report showed a steeper slowdown than most economists – and the Bank of Canada – were expecting. “We’re looking at a situation where the economy has been struggling under the weight of high interest rates and inflation has become quite behaved,” says TD Bank director of economics James Orlando. “(Monetary policymakers) absolutely have enough justification, economically, to cut interest rates. They’ve had that for quite a while.”Following the GDP report, financial markets shifted their odds for an interest rate cut on June 5 to upwards of 80 percent. Many economists also firmed up their expectations that cuts would begin this week, though some held to calls for an initial 25-basis-point drop in July.
Waiting to Cut: Potential Policy Error
One piece of data that could stick out to the Bank of Canada’s governing council is a robust April jobs report, which showed that Canadian employers added 90,000 net new positions in the month. Wage growth eased to 4.7 percent from 5.1 percent the month previous, but the Bank of Canada has signaled that the pace of pay hikes might not be consistent with getting inflation back to the two percent target. Orlando says the trend is clear in the labor market, which has loosened significantly over the course of the rate tightening cycle. Wage growth, while still high, is a lagging indicator as Canadians bid up their pay in an effort to catch up with rampant inflation, and he expects it to continue to cool amid the “stagnant” economy.Cutting interest rates on Wednesday would mark a significant turning point in the Bank of Canada’s efforts to tackle inflation, which began in March 2022 and saw the policy rate rise 4.75 percentage points since then in rapid fashion. Many Canadians have renewed or are set to renew their mortgages amid the new higher interest rates, which will ratchet up their monthly payments and leave less room for spending elsewhere. Some 44 percent of Canadians are still citing money as their biggest stressor, up six percentage points from last year, according to the FP Canada 2024 Financial Stress Index released last month.
