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Economics

Bank of Canada cuts to 4.5%, shifts focus to downside risks

(Bloomberg) -- The Bank of Canada cut interest rates by a quarter percentage point for a second consecutive meeting and signaled further easing ahead as inflation worries wane.

Policymakers led by Governor Tiff Macklem lowered the benchmark overnight rateto 4.5% on Wednesday, as expected by markets and economists in a Bloomberg survey. Officials see sluggish growth continuing to cool inflation, and said they’re spending more time discussing economic headwinds.

Bonds rallied, pushing the two-year Canada benchmark yield to 3.62%, the lowest since May 2023. The loonie tumbled as low as $1.3808 per U.S. dollar, the lowest intraday since April 17, before paring those losses.

“With the target in sight and more excess supply in the economy, the downside risks are taking on increased weight in our monetary policy deliberations,” Macklem said in prepared remarks.

Macklem reiterated that it’s “reasonable” to expect further interest rate cuts, and that the bank will be taking its decisions “one at a time,” pushing back on expectations that the bank is on a predetermined cutting path.

Officials say they’ve continued to make progress on bringing price pressures to heel, and that a return to the 2% inflation target is “in sight.” The June consumer price index, which showed inflation decelerated to a 2.7% yearly pace, also pointed to slowing underlying price pressures, the bank said.

Overall, policymakers seem more convinced that price pressures are under control, and are increasingly focused on preserving a soft landing for the economy. The dovish suite of communications suggest that governing council has shifted their attention to ensuring inflation does not substantially undershoot the 2% target.

It’s a marked shift in the bank’s attitude toward inflation. A summary of deliberations from the officials’ June meeting showed policymakers had debated whether more disinflation proof was needed before easing. Now they’re more convinced they have enough evidence.

“When they start to cut, they tend to cut in clusters,” David Burrows, chief investment officer of Barometer Capital Management Inc., said on BNN Bloomberg Television. “This is the way that it works and it’s time — it’s clearly time.”

The balance of risks is changing too. Officials listed weaker-than-expected household spending as a main downside risk, pointing to upcoming mortgage renewals as a threat to consumption growth. In its statement, the bank said it’s seeing more “signs of slack” in the labor market, and said job-seekers are taking longer to find work.

Macklem Cuts Again | Downside risks taking on "increased weight" in bank's deliberations Bloomberg (Bank of Canada)

In June, the Bank of Canada became the first Group of Seven central bank to cut interest rates. Since then, the European Central Bank has also started easing. Importantly, markets and economists are increasingly convinced the Federal Reserve will also start cutting.

“All in all, the Bank of Canada is still saying that ‘it is reasonable to expect further cuts,’ assuming continuous disinflation. We view this as the ‘default’ now — to cut interest rates, barring any major surprises to inflation,” said Dominique Lapointe, director of macro strategy at Manulife.

“In conjunction with the narrow path to deliver a soft landing, we now expect the Bank of Canada to cut at every remaining meeting this year, leaving the overnight rate at 3.75% in December 2024.”

In the accompanying monetary policy report, the bank kept its economic forecasts roughly the same — growth is expected to remain in excess supply over the forecast horizon. Inflation is expected to rise 2.6% this year, steadily decelerating to reach 2% by the end of 2025.

Housing Market

A sharp rise in housing prices is no longer listed as a main upside risk, and officials cut the contribution of housing to the economy in 2024.

The bank sees growth reaccelerating to a 2.8% annualized pace in the third quarter, driven partly by higher exports from the expanded Trans Mountain pipeline. The economy is expect to expand 1.2% in 2024, revised down from 1.5% previously.

The bank said wage growth, while elevated, is moderating as the labor market loosens. Corporate pricing behavior has “largely normalized”, and inflation expectations have come down.

In June, the final paragraph of the bank’s policy statement had focused on those concerns, but the July statement was largely rewritten to focus on “ongoing excess supply” and “opposing forces” on inflation — the bank sees shelter and services holding up progress.

There was no mention of the recent reacceleration of the three-month moving average of the bank’s preferred core measures, which ticked up to 2.91% in June. Instead, policymakers highlighted progress on the yearly change of median and trim CPI — which is expected to decelerate to 2.5% in the third quarter, according to newly added projections.

Moving more swiftly would allow policymakers to get ahead of coming mortgage renewals, reducing the payment shock for homebuyers who signed on at rock-bottom rates during the pandemic. But cutting too fast has the potential to reignite cost pressures or the country’s supply-squeezed housing market.