Governor of the Bank of Canada Tiff Macklem participates in a news conference on the bank's interest rate announcement, in Ottawa, on Sept. 4.Justin Tang/The Canadian Press
Carl Gomez is the chief economist and head of market analytics at CoStar Group Canada.
On Wednesday the Bank of Canada will likely cut interest rates, but a key question is by how much?
The market is now thinking it will be a jumbo half-percentage-point move. This would not be unprecedented as we’ve seen similar-sized cuts in the past. But over this cycle, the cautious Canadian central bank has opted to cut rates by a minute quarter-percentage point in each of its three latest rate decisions. As a result, at 4.25 per cent, the bank’s benchmark interest rate is still well above what most economists and even the Bank of Canada consider neutral – the rate at which the central bank’s monetary policy is neither stimulating nor holding back the economy.
The central bank has been going too slow. An even bigger cut is warranted on Wednesday, and here’s why.
The inflation dragon that most global central banks worried about after pandemic lockdowns ended has already been slain, especially in Canada. Headline inflation was a mere 1.6 per cent in September, below the 2-per-cent midpoint of the Bank of Canada’s target range, while core inflation looks likely to follow soon. In fact, with many prices for consumer goods coming down sharply as global supply chains fully unwind from their pandemic crunch, housing is now the only major component of the Consumer Price Index (CPI) putting upward pressure on overall inflation.
But housing inflation is being artificially propped up at the moment. Mortgage interest costs are still growing by double-digits, a reflection of the Bank of Canada’s sharp interest-rate hikes in 2022 and 2023. Meanwhile, rent inflation as tracked by the CPI only eased to 8 per cent in September. This figure masks the reality of what is happening on the ground.
Real estate data companies are reporting a significant cooling in rent growth. For example, Canada’s average asking apartment rent grew by just 3 per cent in the third quarter compared to the previous year, well below the 10-per-cent peak growth rate in early 2023. Rent controls and landlords’ inability to turn over rental apartment units due to high occupancy are increasingly cited as key factors slowing things down. Meanwhile, a growing inventory of condo rental listings and a surge of new purpose-built rental apartments whose higher-than-average rents are bumping into affordability constraints are expected to put further downward pressure on rental growth in the months ahead.
Given these anomalies, the Bank of Canada should fully discount the distorted impact of housing costs. By doing so, inflation is just 0.4 per cent as of September. This is not only well below the Bank of Canada’s target range, but puts the country at risk of deflation.
Meanwhile, inflation expectations have also dropped sharply. According to the Bank of Canada’s own third-quarter business outlook survey, only 15 per cent of respondents expect inflation to be above 3 per cent over the next two years – down sharply from 84 per cent in the fourth quarter of 2022. Similarly, firms’ expectations of wage growth declined for the first time since early 2023. In other words, weary consumers and businesses believe inflation is dead.
This brings us to another key reason why the Bank of Canada is behind the curve with interest rate cuts – the weak economy.
Economic growth for the third quarter was below the Bank of Canada’s estimates. Although growth in real gross domestic product (GDP) remains positive and has defied the traditional definition of recession (two consecutive quarters of negative growth), its positive performance is largely due to surging population growth, which will likely reverse going forward. Moreover, in per capita terms, real GDP growth has declined for several consecutive quarters. As a result, Canadians likely feel like the country has been in a recession for years.
A particular sore spot is the housing market. Home sales are down sharply due to higher interest rates, poor affordability and a protracted housing shortage. Many homeowners are facing a significant increase in payments as their fixed-rate mortgages reset from rock-bottom levels. Although variable-rate mortgage holders might get some breathing room as prime lending rates come down, many of those variable-rate mortgage holders are still seeing their payments go higher due to deferred interest charges. This is a classic example of how there are long lags with monetary policy. Past rate hikes are still being felt by many Canadians.
The bottom line is that with inflation dead, Canada’s economy is in need of sharper interest-rate cuts. To get ahead of the curve, the Bank of Canada should consider even bigger cuts than half a percentage point. This would help to get interest rates back down to neutral levels faster. Front-loading hikes was what happened when the BoC hiked rates by a full percentage point in July, 2022, when it grew fearful of surging global inflation. The same argument could be made in reverse today.