The Bank of Canada cut interest rates Wednesday for the first time since launching a historic hiking cycle to combat inflation in March 2022, marking a significant shift in monetary policy that could open the door to additional cuts in the coming months.

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Bank of Canada's Tiff Macklem signals more rate cuts possible after historic shift Back to video

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The central bank set its overnight rate at 4.75 per cent, down 25 basis points from the five-per-cent level that had been in place since rates peaked in July 2023.

“With continued evidence that underlying inflation is easing, Governing Council agreed that monetary policy no longer needs to be as restrictive,” the Bank of Canada said in a statement Wednesday, adding that recent data has increased confidence that inflation will continue to move toward the central bank’s target of two per cent.

Inflation fight

“We’ve come a long way in the fight against inflation,” Bank of Canada governor Tiff Macklem said during a news conference following the rate announcement. “The considerable progress we’ve made to restore price stability is welcome news for Canadians.”

Over the past couple of years, Canadian consumers have struggled to keep up with inflation and then higher interest rates, with some falling behind on credit cards and car payments and as they faced higher monthly bills from food to rent and mortgage payments.

Markets had been betting on a cut this month after six consecutive holds leading up to Wednesday’s announcement and are now pricing in a further cut in September.

Interest rate cuts to come

Arlene Kish, director of Canadian economics at S&P Global Market Intelligence, said in a note Wednesday that there could be two more 25-basis-point cuts this year and five more by the end of 2025, bringing the key overnight rate down to three per cent.

Macklem, who has previously indicated that rates are unlikely to come down as quickly as they were ratcheted up, said it would be reasonable to expect further rate cuts if inflation continues to ease and central bankers become increasingly confident that it is headed sustainably to the two per cent target level.

“But we are taking our interest rate decisions one meeting at a time,” he said. “We don’t want monetary policy to be more restrictive than it needs to be to get inflation back to target. But if we lower our policy interest rate too quickly, we could jeopardize the progress we’ve made.”

Further progress in bringing down inflation is likely to be uneven, he said, and risks to the outlook remain.

“Inflation could be higher if global tensions escalate, if house prices in Canada rise faster than expected, or if wage growth remains high relative to productivity,” Macklem said.

Shelter price inflation remains high, contributing to overall inflation above the central bank’s target, he said, but he added that total consumer price inflation has declined consistently over the course of this year, with indications that underlying inflation is at a point of “sustained easing.”

For example, CPI inflation eased to 2.7 per cent in April from 3.4 per cent in December, while the Bank of Canada’s preferred measures of core inflation had come down to about 2.75 per cent in April from about 3.5 per cent last December. Meanwhile, the three-month rates of core inflation slowed to under two per cent in March and April from about 3.5 per cent in December.

In a further indication that price increases are no longer “unusually broad-based,” Macklem pointed to the proportion of CPI components increasing faster than three per cent, which is now close to the historical average.

And while economic growth fell behind Bank of Canada projections in the first quarter, at 1.7 per cent on an annualized basis, he noted that it recovered from a stall in the second half of last year and consumption growth proved solid at three per cent.

Business investment and housing activity also increased and businesses are continuing to hire workers.

“Employment has been growing, but at a slower pace than the working-age population,” Macklem said. “This has allowed the supply of workers to catch up with job vacancies. Elevated wage pressures look to be moderating gradually.”

Central bankers will continue to closely watch the evolution of core inflation, he said, and remain particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.

Bank of Canada on slow path

James Orlando, a senior economist at Toronto-Dominion Bank, said the Bank of Canada has finally been convinced by what other markets watchers were seeing in terms of softening inflationary pressures.

“Like that one neighbour who has let their yard become overgrown, the BoC has heard the complaints and decided to bring out its policy trimmers to cut rates,” he said in a note Wednesday. “While the BoC has waited longer than we would have hoped, today starts the process of lower interest rates for Canadians going forward.”

However, he said the Bank of Canada is likely to adopt a cut and pause path to bringing rates down, with the next cut in September. Central bankers will want to avoid a rebound in inflation, as the United States has experienced, and to keep the housing market from getting overheated by a rush of prospective buyers who were waiting for lower rates, he said.

“We believe that the path forward for the BoC is going to be slow,” Orlando wrote.

Victor Tran, a mortgage broker and realtor with comparison site Rates.ca, said the rate decrease is likely to spur some activity in the housing market over the summer, but won’t alleviate the pressure keeping many out of the market.

“Rate decreases may loosen up what has been a sluggish housing market for much of the year, but the buyers that were limited by high rates before the cut are likely to still be limited by high rates after the 25-basis-point drop,” he said.

The Bank of Canada’s interest rate cut Wednesday put the central bank on a different trajectory than the U.S. Federal Reserve, which is not expected to begin cutting rates before September. The U.S. economy has been running hotter than Canada’s and inflation has not come down steadily.

Some commentators fear the divergence will punish the loonie and that the effects of a lower Canadian dollar could seep into other parts of the economy.

“The Bank of Canada will have to walk a careful line here between normalizing interest rates in support of the Canadian economy, but not going too far such that the unintended consequence is a much weaker loonie,” said Philip Petursson, chief investment strategist at IG Wealth Management.

In a note, he said that if the Bank of Canada cuts rates by 50 basis points more than the Fed in 2024, there is a risk of the loonie falling to between 70 and 72 cents US.

At the news conference, Macklem said the two North American central banks have diverged on monetary policy direction and pace in the past and while he acknowledged that there is a limit to how far apart they can be before negative impacts are felt, he said he is not concerned about a significant impact on either economy at this point.

“Conditions are different…. I don’t think we’re close to that limit (of divergence),” he said. “There’s no … bright line and you can see from history there have been periods of considerable divergence.”

• Email: bshecter@postmedia.com

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