Bank of Canada cuts its key interest rate by a half-point to 3.75%

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The Bank of Canada delivered an oversized interest-rate cut on Wednesday and said that its fight with inflation is almost over, accelerating the pace of monetary policy easing in an attempt to engineer a soft landing for the Canadian economy.

As widely expected, the bank’s governing council lowered the benchmark policy rate by half a percentage-point to 3.75 per cent. This is the fourth consecutive cut since June and follows three quarter-point moves.

“We took a bigger step today because inflation is now back to the 2-per-cent target and we want to keep it close to the target,” Bank of Canada Governor Tiff Macklem said in a press conference after the rate announcement. “We need to stick the landing.”

He said the bank expects to continue lowering interest rates, but added that the pace of cuts will depend on incoming economic data. Financial markets expect the policy rate to fall to around 2.5 per cent by the end of next year.

Mr. Macklem stopped just short of declaring mission accomplished during the press conference, saying that Canadians no longer needed to fret about widespread price increases, even if the prices for many goods and services themselves will remain higher than before the bout of inflation.

“It’s been a long road back from the high inflation we experienced coming out of the pandemic,” he said. “We’re coming out the other side, and I think Canadians can breathe a sigh of relief.”

The larger-than-usual rate cut follows a string of data showing that both inflation and economic growth in Canada are running below what the bank expected. With price pressures essentially under control, central bankers are now trying to get borrowing costs back to a neutral level that doesn’t restrain growth to avoid a recession and a further rise in unemployment.

The bank’s forecast, published Wednesday, sees economic activity picking up toward the end of the year and into next year, with falling interest rates expected to spur business investment and consumer spending on interest-sensitive goods such as cars and houses.

An increase in per-person spending will be partly offset by slowing population growth, following the new federal caps on temporary immigration, the bank said.

Financial market reaction to the announcement was muted as investors were widely anticipating a half-point cut. The yield on two-year Government of Canada bonds fell a few basis points on the news, but ended the day up slightly. The Canadian dollar weakened a tad against the U.S. currency.

Market speculation turned quickly to the next rate decision on Dec. 11. Interest rate swap markets put the odds of a quarter-point cut above 90 per cent, according to LSEG data. But some Bay Street economists think the bank could deliver another oversized move.

“There’s no real logic in taking baby steps towards getting interest rates to a level that won’t needlessly hold back economic growth,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in note to clients.

“With the current 3.75 per cent rate still in restrictive territory, it would take a major turn of events to stand in the way of another 50 basis point reduction in December, driven by the same logic as today’s decision.”

Don’t count on another jumbo-sized rate cut: How markets and economists are reacting to today’s BoC decision

Wednesday’s rate cut should offer some relief to homeowners with variable rate mortgages. Interest rates on fixed-rate mortgages, by contrast, are likely to move less; they are based on longer-term bond yields, which have already moved down in anticipation of future rate cuts.

Canada’s housing market has largely remained dormant since the central bank started lowering rates in June. The bank flagged a potential rebound in real estate spending as an upside risk to both growth and inflation. But senior deputy governor Carolyn Rogers said that there was plenty of uncertainty around this.

“It is possible that the combination of lower interest rates and changes in mortgage rules [that come into force in December] could mean that that pickup happens sooner or faster or stronger than we expect,” Ms. Rogers said in the press conference.

“It’s also possible people will look at the direction of interest rates and sort of stay on the sidelines a bit longer and wait for rates to come down more.”

Robert Kavcic, senior economist at Bank of Montreal, isn’t expecting a surge in real estate activity in the near-term, even with Wednesday’s rate cut. Too many would-be buyers remain priced out of the market, and fixed-rate mortgages may have already bottomed out given the movement in bond yields, he said in an interview.

“If we’re worried about the market really taking off again and going back to really tight market conditions and double-digit price growth, I think we’re quite some time away from that still,” he said.

All of this is playing out against the backdrop of falling Consumer Price Index (CPI) inflation, which has declined much faster than either the Bank of Canada or Bay Street predicted even a few months ago.

The annual rate of CPI growth hit the bank’s 2-per-cent target in August for the first time since 2021 then fell to 1.6 per cent in September, pulled lower by falling oil prices. The bank expects headline inflation to perk back up above 2 per cent in the coming months, and then to fluctuate around the target going forward.

Price growth has slowed for a broad range of products and services, particularly for consumer goods such as cars and clothing. However, there are still pockets of inflation. Shelter price inflation, in particular, remains high because of rapid rent increases and rising mortgage interest costs tied to past interest rate hikes.

The bank now sees upside and downside risks to inflation as “reasonably balanced,” and policy makers are equally concerned about inflation overshooting and undershooting the target.

High interest rates have taken a toll on the economy. Canada has avoided a recession, thanks to rapid population growth that has kept the overall economy growing while individuals have tightened their purse strings. But on a per capita basis, GDP has contracted for much of the past two years. Unemployment has risen sharply, especially for young people and immigrants.

The bank expects economic activity to increase gradually as interest rates fall. Its new forecast sees Canadian output growing 2.1 per cent in 2025 and 2.3 per cent in 2026, up from 1.2 per cent in 2024. Per capita GDP growth is expected to turn positive next year.

The expected rise in individual spending will be partly offset by the slowdown in population growth, which the bank expects to fall from around 2.5 per cent in the second half of 2024 to an average quarterly growth of 1.5 per cent in the coming years.