Understanding the Bank of Canada's Recent Rate Cut: What It Means for Canadians

The Bank of Canada has recently announced a reduction in its target for the overnight rate to 4.5%, with the Bank Rate set at 4.75% and the deposit rate at 4.5%. This move comes as part of the Bank's ongoing strategy to normalize its balance sheet while addressing the current economic climate both globally and domestically.

Global Economic Context

The global economy is projected to grow at an annual rate of about 3% through 2026. Despite inflation rates still being above targets in many advanced economies, there are signs of gradual easing. In the United States, an economic slowdown is evident, with a decrease in consumption growth, though inflation appears to be on a downward trajectory. The euro area is experiencing a recovery after a sluggish 2023, while China's economy shows modest growth due to weak domestic demand, which is somewhat counterbalanced by strong export activity. Global financial conditions have also improved, with lower bond yields, rising equity prices, and robust corporate debt issuance. The Canadian dollar remains stable, and oil prices are in line with previous forecasts.

Canada's Economic Landscape

In Canada, economic growth has likely picked up to about 1.5% in the first half of this year. However, given the robust population growth of approximately 3%, the country's potential output is expanding faster than its GDP, indicating an increase in excess supply. Household spending has been weak, including both consumer purchases and housing. The labor market shows signs of slack, with a rising unemployment rate now at 6.4%, and employment growth lagging behind the growth of the labor force. While wage growth is moderating, it remains elevated.

Looking ahead, GDP growth is expected to rise in the latter half of 2024 and through 2025, driven by stronger exports and a recovery in household spending and business investment, facilitated by easing borrowing costs. Residential investment, in particular, is projected to grow robustly. With new government limits on admissions of non-permanent residents, population growth is expected to slow in 2025, further influencing economic dynamics.

The Bank forecasts GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. This gradual strengthening of the economy is expected to absorb excess supply through 2025 and into 2026.

Inflation Trends and Outlook

CPI inflation moderated to 2.7% in June after an increase in May, with broad inflationary pressures easing. The Bank's preferred measures of core inflation have been below 3% for several months, aligning more closely with historical norms. However, shelter price inflation remains high, largely due to elevated rent and mortgage interest costs, and continues to be a significant contributor to overall inflation. Inflation is also higher in services closely tied to wage growth, such as restaurants and personal care.

Looking forward, core inflation is expected to slow to about 2.5% in the second half of 2024, gradually easing through 2025. CPI inflation is predicted to dip below core inflation in the latter half of this year, influenced by base year effects on gasoline prices. Once these effects dissipate, CPI inflation may rise slightly before stabilizing around the 2% target next year.

Monetary Policy Implications

The recent rate cut reflects the Bank's assessment of the economic landscape, balancing the need to reduce inflationary pressures with the recognition of ongoing excess supply in the economy. While inflation in some sectors, particularly shelter and certain services, remains elevated, the overall trend indicates easing price pressures.

The Bank of Canada's commitment to restoring price stability remains firm. Future monetary policy decisions will be guided by incoming data and their implications for the inflation outlook. For Canadians, these developments signal a cautious but deliberate approach to fostering economic stability and growth.