Bank of Canada Governor Tiff Macklem participates in a news conference on the bank's interest rate announcement on July 24.Justin Tang/The Canadian Press
On Aug. 7, Globe and Mail reporters Mark Rendell and Matt Lundy answered reader-submitted questions about the Bank of Canada’s long-awaited back-to-back interest rate cuts. The central bank first lowered the policy rate to 4.75 per cent in June from 5 per cent – a level reached last summer after one of the most aggressive campaigns of rate hikes on record. It then opted to cut the benchmark interest rate for a second consecutive time in July to 4.5 per cent, teeing up additional rate cuts this year.
Readers asked about the impact the rate cut will have on the housing market, inflation, Canada’s GDP and productivity levels. Here are some highlights from the Q+A.
The effects on the housing market
How do you foresee the housing market reacting to lower interest rates? Will this lead to another rapid price escalation as Canadians and investors rush back into the market?
Matt Lundy: I wish I had a crystal ball for this one. I’d imagine that lower interest rates will help people get into the housing market, which has been slumping for much of the past two years. Still, it’s tough to envision the type of price escalation we saw from 2020 through early 2022 – effectively, the rock-bottom interest rate era. Those increases were frankly out of the ordinary. Also, the Bank of Canada has stressed that interest rates are likely not going back to the meagre levels we’ve seen for much of the past 15 years.
On the rental side, lower rates will probably help get some developments off the ground. In fact, in many parts of the country, housing starts are trending higher and many governments are encouraging homebuilding in various ways.
Has the BoC modelled the impact of mortgage renewals on the economy for the next two years?
Mark Rendell: Canada will be facing something of a mortgage renewal wall over the next two years. So far, only around half of all homeowners with mortgages have seen their monthly payments rise since the BoC started raising rates in 2022. The other half will see their mortgages reset over the next two years, and many are in for a shock, having taken out large mortgages to get into the market in 2020 and 2021 when interest rates were at rock bottom.
In its financial stability report published in May, the BoC estimated homeowners with a variable rate mortgage with a fixed monthly payment could see their median monthly payment rising by more than 60 per cent in 2026. In 2025, the median increase is more than 50 per cent; this year, about 30 per cent. For people with a fixed-rate mortgage, the sharpest rise will occur in 2026, with the median increase being more than 20 per cent.
Will the lower mortgage rates help younger Canadians who are struggling to afford a home? Is there a number the rate can be lowered to before it finally becomes affordable again?
Lundy: Well, many people found housing unaffordable when the BoC’s overnight lending rate was at 0.25 per cent in 2020 through early 2022. Lower mortgage rates will probably help some younger Canadians get into the housing market because stress tests will become less onerous and monthly mortgage costs more manageable. The flip side is that lower rates could put upward pressure on prices. The bigger issue is that Canada isn’t building enough homes to meet demand.
The potential impact on inflation
What is the correlation between interest rates, inflation and wages? Does one go up when the others do?
Rendell: Inflation is driven by a number of factors, but one of them is a tight labour market and rising labour costs. In effect, companies sometimes raise their prices to cover the rising wages they’re paying their employees. If this happens economy-wide it can feed into inflation, which in turn may necessitate higher interest rates. This dynamic is one reason the BoC is so focused on labour market tightness, which it assesses based on a number of metrics, such as the unemployment rate and job vacancies.
For most of the past year, the BoC has said that wages are growing too fast to be compatible with 2 per cent inflation goal. It’s not a message workers like to hear, and unions have criticized the central bank for what they perceive as anti-worker rhetoric. But many economists would agree with the BoC that it’s hard to achieve 2 per cent inflation if average wages are growing at 4 or 5 per cent unless you also have a big increase in productivity – that is output per worker.
How much of an impact will rates have on GDP per capita growth?
Rendell: Restrictive interest rates are designed to slow down economic growth – the whole idea is to restrict demand for goods and services to reduce upward pressure on prices. Lowering interest rates should help stimulate growth. As for how this will feed into GDP per capita, that’s a question tied to both overall growth and population growth. If you have rapid population growth and tepid overall growth that’s going to show up as declining GDP per capita – something we’ve seen in Canada over the past two years.
With the BoC expecting economic growth to pick up over the next year (partly as a result of easing monetary policy) and population growth expected to cool due to federal caps on non-permanent residents announced this spring, that should start showing up as improving GDP per capita. But it will likely take some time to return to the GDP per capita growth trend seen before the pandemic.
Should we still be worried about the possibility of higher inflation in coming months or do you think we’re finally out of the woods?
Rendell: The inflation genie isn’t entirely back in the bottle, but we’re getting there. The latest CPI numbers showed the annual rate of inflation was running at 2.7 per cent in June, down from a peak of 8.1 per cent in mid-2022. There were some signs that inflationary pressure remains. The bank’s two measures of core inflation ticked higher on a three-month basis in June, and inflation remains sticky in parts of the service sector, especially for services whose prices are closely tied to labour costs. Housing-related inflation – think rents and mortgage interest costs – remains worryingly high.
But there are also signs that headline inflation will continue trending lower. Goods price inflation has dropped considerably, and wage pressures are easing. At a very high level, the overall balance between supply and demand in the economy is showing a negative “output gap” which suggest further downward pressure on prices.
An eye on productivity
Is the BoC concerned with the low productivity levels in Canada and how does this factor into their rate decisions?
Lundy: The central bank is absolutely concerned about this. Senior Deputy Governor Carolyn Rogers gave a speech earlier this year, saying that Canada had a productivity “emergency.” She noted that “when the entire economy becomes more productive, that means the country can have more growth before we see upward pressure on inflation.” From a central banking perspective, “increasing productivity is a way to protect our economy from future bouts of inflation without having to rely so much on the cure of higher interest rates,” she said.
Does the BoC believe rapid population growth is adversely affecting our productivity?
Lundy: BoC officials have given speeches about the country’s productivity “emergency” and the impact of strong population growth on housing costs and inflation. To my knowledge, they haven’t linked the two together. Researchers at the Federal Reserve Bank of St. Louis published an article in June about the effects of worker scarcity, saying “If firms increasingly turn to automation in response to labour shortages, we should expect to see improvements in labour productivity.”
When labour demand was rising sharply over 2021 and 2022, Ottawa took a different approach, finding ways of expanding employers’ access to foreign labour, which has contributed to the fastest population growth in decades. Many companies have tapped into low-wage labour rather than invest in equipment, software and other things that could boost productivity.
The upcoming rate announcement
How likely is the BoC to cut the rate by .5 basis points in September? When will we reach a 1 per cent drop from the high?
Lundy: I’d say it’s quite unlikely the BoC cuts by half a percentage point in September. Central bank officials have repeatedly said they’re not on a predetermined schedule for cutting – although, the path is heading lower. Their communications, along with recent economic data, suggest another 25-basis-point is coming next month, a view that is widely held on Bay Street. You’d likely need to see a significant deterioration in economic conditions over the next four weeks for a half-point cut. Many analysts think the bank will cut at each of its three remaining decisions this year, so you’d end up with a 4 per cent benchmark lending rate by October.
Will the next rate review in September be affected by the slower U.S. economy?
Lundy: Canada’s economic fortunes are tied to U.S. performance, so this absolutely factors into BoC decision-making. The U.S. economy is slowing (take a look at recent labour market results) but other metrics point to a solid expansion. The U.S. economy grew at an annualized rate of 2.8 per cent in the second quarter, and the Federal Reserve Bank of Atlanta expects similar growth in the third quarter. Even so, investors are lining up behind the view that the Federal Reserve will begin cutting U.S. interest rates in September. This is likely good news for the BoC, because it means their divergence from the Fed is nearing an end.
What does this mean for the Canadian dollar?
Rendell: If the BoC cuts interest rates while the U.S. Federal Reserve remains on hold that should, theoretically, put downward pressure on the Canadian dollar. So far there has not been much movement in CAD-USD since the BoC only started cutting in June. Markets expect the Fed to start easing in September, which should prevent too much divergence between Canadian and U.S. interest rates. But you could see larger currency swings if the Fed is more cautious than markets expect. Tiff Macklem, Governor of the BoC, has said there is a limit on how far the BoC can get ahead of the Fed on easing – a drop in CAD could, after all, feed into inflation by pushing up the price of imports. But he has said we are not yet close to those limits.