The Bank of Canada is poised to make a significant shift in monetary policy on Wednesday, with markets and economists widely expecting a large interest rate cut of 50 basis points, bringing the policy rate down to 3.75%, Bloomberg reports.
This would be the most aggressive rate reduction since the onset of the COVID-19 pandemic, reflecting a growing concern over cooling inflation and stagnating economic growth.
The large cut, anticipated by all but one of Canada’s major banks, signals a sense of urgency to bring the benchmark overnight rate closer to the “neutral” level, where it neither stimulates nor hinders economic activity. With inflation now below the Bank of Canada’s 2% target and economic growth lagging behind projections, restrictive borrowing costs are deemed unnecessary.
Some analysts express concern that maintaining a gradual easing pace might not be sufficient to prevent inflation from falling too low or even triggering deflation. These concerns have fueled speculation that the central bank might adopt a more aggressive approach to easing.
Governor Tiff Macklem hinted at the possibility of larger rate cuts in September, stating that the bank could accelerate easing if inflation and growth weakened further. Recent data seem to confirm this trend.
Inflationary pressures have slowed significantly, with the year-on-year rate dropping to 1.6% in August, driven by falling gasoline prices. The average inflation rate in the third quarter has remained below the 2.3% forecast made in July. Furthermore, preliminary data suggest that economic growth in the third quarter is closer to 1%, significantly lower than the 2.8% annualized growth rate the Bank of Canada projected.
The Canadian economy faces mounting downside risks. Although a recession is not the current base case scenario, growth has stalled and is largely reliant on record levels of immigration. The labor market is weakening, with Canadians facing higher mortgage rates and constrained household spending.
While this significant rate cut might be perceived as a sign of concern about an economic downturn, the Bank of Canada is expected to emphasize that it is simply adapting its policy to the evolving economic landscape.
However, there are concerns about cutting rates too quickly, particularly given the persistent underlying inflation and the potential for a resurgence in housing speculation. Lower mortgage rates could reignite activity in the housing market, potentially reversing the progress made in reducing household debt levels.
