Bank of Canada Governor Tiff Macklem speaks in Ottawa on June 5.Justin Tang/The Canadian Press
The Bank of Canada is expected to deliver a second dose of interest-rate relief this week, as inflation moderates and economic growth remains sluggish.
The central bank began a long-awaited easing cycle last month, lowering its policy rate to 4.75 per cent from 5 per cent – the first cut in four years. There’s a broad consensus among analysts and traders that Governor Tiff Macklem and his team will follow up with another quarter-point cut on Wednesday.
The highest interest rates in two decades have done their job, curbing consumer spending, cooling the overheated housing market and rebalancing supply and demand in the economy. That’s helped re-anchor consumer prices: Inflation has been below 3 per cent since the start of the year, down from a peak of 8.1 per cent two years ago.
With inflation closing in on the central bank’s 2-per-cent target and the Canadian economy stuck in the doldrums, current interest-rate levels look too restrictive. The question is how fast the Bank of Canada will move to get borrowing costs back to a more neutral level.
“If you start to lower too fast and things just pick up and you get inflation again, you’ve wrecked your credibility a little bit,” said Jeremy Kronick, director of the Centre on Financial and Monetary Policy at the C.D. Howe Institute in an interview.
“But if you look at the trend, it’s pretty good. Inflation has gone down … and the economy is definitely softening.”
Mr. Macklem said last month that it’s “reasonable” to expect further rate cuts if price pressures keep easing. Since those remarks, May inflation data came in surprisingly hot. But the June numbers, published last week, showed inflation back on a downward path, with headline inflation falling to 2.7 per cent.
“Disinflation continues to be the theme, and spread across categories in the Consumer Price Index from furniture prices to grocery prices,” said Tu Nguyen, an economist with RSM Canada, in an interview.
“In fact, the only stubborn part of inflation that’s left is shelter. But that is not going to get fixed by keeping rates high, because we know that a big part of shelter inflation is actually mortgage interest payments, which are rising because of the higher interest rates.”
There was a sour note in the June inflation data. The bank’s two preferred measures of core inflation, which strip out the most volatile price movements, moved higher on a three-month basis.
Financial markets shrugged this off. Interest rate swap markets, which capture expectations about monetary policy, put the odds of a quarter-point cut on Wednesday at around 90 per cent, according to Refinitiv data. Twenty-two out of 30 economists polled by Reuters said they expect a cut this week.
Ultimately, the central bank isn’t just looking at where inflation is today. It’s trying to figure out where it will be in six to eight quarters, and most signposts point to further easing of price pressures.
The unemployment rate in Canada has risen to 6.4 per cent from a record-low 4.8 per cent two years ago. Businesses aren’t laying off workers in large numbers, but job creation has failed to keep pace with rapid population growth. A looser labour market implies slower wage growth, which can influence how companies set prices.
Meanwhile, the pullback in consumer spending on discretionary goods and services means that businesses can’t be as aggressive raising prices. A Bank of Canada survey, published last week, found that most businesses expect sales to be weak over the next year and that few are planning large wage or price increases.
The central bank will publish a new forecast for inflation and economic growth on Wednesday in its quarterly Monetary Policy Report.
“The economy is now operating with visible disinflationary economic slack, as evidenced by labour market softness and an extended run of mediocre growth that has trailed the Bank’s estimate of the economy’s non-inflationary potential,“ wrote Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, in a note to clients.
“Current interest rates would be a hurdle towards any improvement, with the Bank likely to again mention mortgage renewals as a drag ahead.”
Another rate cut would be good news for homeowners with variable-rate mortgages, which track changes in the central bank’s policy rate.
It might not, however, have a big impact on interest rates for fixed-rate mortgages. These are determined by bond yields. And bond markets have already adjusted in expectation of monetary policy changes, said Robert Hogue, assistant chief economist at Royal Bank of Canada, in an interview.
“It’s going to take a little while longer for interest rate cuts really to have an impact on the [housing] market via a broader drop in rates, and not just for variable rates.”
Real estate markets in some Canadian cities perked up after the rate cut in June. But there hasn’t been a flood of sales or surge in prices, as many would-be buyers remain sidelined by prohibitively high mortgage rates.
“I would not expect the market to take off either after a rate cut [this] week,” Mr. Hogue said. “I think it’s going to take a while for confidence to build, and also for cuts to make a difference.”