Bank of Canada Governor Tiff Macklem at a news conference, after cutting key interest rate for the first time in four years in Ottawa on June 5.Blair Gable/Reuters
The Bank of Canada cut its benchmark interest rate by a quarter percentage point on Wednesday, lowering borrowing costs for households and businesses for the first time in four years and marking a turning point for the Canadian economy after the biggest inflation and interest-rate shock in decades.
The central bank’s governing council lowered the policy rate to 4.75 per cent from 5 per cent, a two-decade high reached last summer after 10 rapid-fire rate hikes in 17 months.
“With further and more sustained evidence underlying inflation is easing, monetary policy no longer needs to be as restrictive,” Governor Tiff Macklem said in a press conference after the announcement. “In other words, it is appropriate to lower our policy interest rate.”
The highly anticipated move won’t do much, by itself, to reduce monthly payments on mortgages, car loans or lines of credit. But it kick-starts a monetary policy easing cycle that should see interest rates fall further in the coming quarters, offering some relief to borrowers with floating-rate debt, homeowners facing mortgage renewals and indebted governments.
It could also breathe life back into the Canadian real estate market, which has stagnated over the past two years as would-be buyers have had trouble qualifying for mortgages and sellers have held off listing owing to uncertainty about the trajectory of the market.
The Bank of Canada is the first G7 central bank to start easing monetary policy. The European Central Bank is expected to follow suit on Thursday, while the U.S. Federal Reserve, which is dealing with a stronger economy and more stubborn inflation, is expected to hold off rate cuts until later in the year.
Mr. Macklem said that more relief is likely on the way. Although he was reluctant to put rate cuts on a timetable and warned that the path down could be gradual.
“If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2-per-cent target continues to increase, it is reasonable to expect further cuts to our policy interest rate. But we are taking our interest-rate decisions one meeting at a time,” he said.
In the wake of the announcement, bonds rallied and yields fell, while the Canadian dollar weakened against the U.S. dollar, dropping briefly into the US$0.72 range before rebounding. Bay Street traders, meanwhile, upped their bets on further cuts this year.
Interest-rate swap markets, which capture expectations about monetary policy, now put the odds of another rate cut at the next BoC meeting on July 24 at around 40 per cent, according to Refinitiv data. Markets are pricing in two more cuts between now and the end of the year.
“The first cut may not necessarily be the deepest, but it is the most significant, as it marks the official turning point after more than two years of restrictive policy,” Douglas Porter, chief economist at Bank of Montreal, said in a note to clients.
“This is indeed likely to be the first of a series of cuts, although that series is not going to be a straight line down by any means. The bank’s tone is a bit more dovish than expected, but each and every cut this year will require evidence that inflation is calming.”
High interest rates, combined with inflation and broader housing affordability concerns, have become a political millstone for the federal government. After the announcement, Finance Minister Chrystia Freeland called the decision “welcome news for Canada and for Canadians.” This was echoed by Ontario Premier Doug Ford, who posted on X: “It’s about time.” The Bank of Canada makes monetary policy independently from politicians.
The pivot by the central bank – which is Mr. Macklem’s first rate cut since becoming governor four years ago – is a milestone after one of the most turbulent periods in the central bank’s history.
After holding interest rates near zero through the first two years of the COVID-19 pandemic, the bank’s governing council launched into the most aggressive rate-hiking cycle on record in a bid to get runaway inflation back under control.
Over just 17 months, starting in March, 2022, they raised the benchmark overnight rate from 0.25 per cent to 5 per cent, dramatically increasing the cost of borrowing money and servicing debt and squeezing the finances of homeowners, businesses and governments.
A recent history of Bank of Canada’s interest rate decisions
The goal of higher interest rates is to curb demand for goods and services, reducing upward pressure on prices and acting as a brake on inflation. In other words, the central bank has been purposefully hurting the economy to achieve price stability.
The campaign appears to have worked, aided by a decline in global commodity prices and improving supply chains. After running as high as 8.1 per cent in the summer of 2022, annual consumer price index inflation fell below 3 per cent at the start of this year and hit 2.7 per cent in April.
“Inflation remains above the 2-per-cent target and shelter inflation is high,” Mr. Macklem said Wednesday. “But total consumer price index inflation has declined consistently over the course of this year, and indicators of underlying inflation increasingly point to a sustained easing.”
This has not been without costs. The Canadian economy has flatlined over the past year, and actually shrank on a per capita basis. Business insolvencies are up and the unemployment rate has risen a full percentage point as job creation has failed to keep pace with population growth.
Consumers, meanwhile, have dialled back spending to cope with higher debt payments or to squirrel money away ahead of a painful mortgage renewal.
Still, the process of disinflation has gone smoother than many economists and central bankers expected.
The Canadian economy has not fallen into a recession. Mortgage delinquencies remain low. And after stalling last year, economic growth picked up in the first quarter, led by consumer spending.
“We’ll certainly be looking at our growth trajectory going forward. But ... so far it is looking like a soft landing,” Mr. Macklem said. “The plane hasn’t been landed yet so we’re not cheering yet. But I would say the runway is in sight.”
Of course, things could still get worse before they get better.
Opinion: How fast and how far for further rate cuts, Bank of Canada?
Even after the cut on Wednesday, interest rates remain highly restrictive. They won’t actually start supporting economic growth until much later in the easing cycle.
Meanwhile, the country is facing a wall of mortgage renewals. Only about half of all homeowners with mortgages have renewed since rates started to rise in 2022. The other half, many of whom took on large mortgages when interest rates were at rock-bottom during the pandemic, are looking at huge payment shocks when they renew over the next few years.
“The headwinds from mortgage renewals are likely to be stiff enough to require a series of rate cuts in order to achieve a soft landing,” Royce Mendes, head of macro strategy at Desjardins, said in a note to clients.
“Assuming the US economy continues to cool off and population growth slows down, a risk management approach to monetary policy clearly favours consistent rate cuts extending well into next year and maybe even beyond.”
There are constraints on how fast and how far the Bank of Canada can go. If it gets too far ahead of the U.S. Federal Reserve on rate cuts, that would put downward pressure on the Canadian dollar, pushing up the price of imports. Although Mr. Macklem played down this concern during the press conference: “There are limits to how far we can diverge from the United States, but we’re not close to those limits,” he said.
Other inflationary risks remain. Home prices could jump if buyers, sidelined by high mortgage rates and uncertainty, flood back into the market. And geopolitical shocks could push up the price of oil and other commodity prices.
“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,” Mr. Macklem said.