Bank of Canada Cuts Interest Rate Amid Mixed Signals

Bank of Canada Cuts Interest Rate Amid Mixed Signals

Published on: July 25, 2024

Category: InsightsNews

As expected, the Bank of Canada (BoC) announced a further 25 basis point cut in its key interest rate on Wednesday, bringing it to 4.5%. This is the second consecutive rate cut since June when the rate reached 5% following a period of sharp increases aimed at easing post-pandemic inflation.

The Central Bank stated that its decision was prompted by evidence of progress in inflation reduction and the downturn in economic conditions. In a press briefing, Governor Tiff Macklem said, “The economy’s potential output is still growing faster than GDP, which means excess supply has increased.” While continued excess supply reduces inflationary pressures, price pressures in shelter and other services affect inflation upward. The Governing Council carefully assesses these opposing forces to avoid the risk of stronger-than-expected setbacks.

Here are a few observations made by the Bank of Canada in the press release issued following its July 24 decision:

• Economic growth in Canada has been revised down from 1.5% to 1.2%.
• The unemployment rate rose to 6.4% as employment grew more slowly than the active population.
• Following a rise in May, inflation, as measured by the Consumer Price Index (CPI), moderated to 2.7% in June.
• The scale of price rises among CPI components is now close to the historical average.
• The rise in housing costs remains strong, driven by rents and mortgage interest costs, and remains the biggest contributor to inflation.

To some extent, the Bank of Canada’s statement may seem contradictory to the information provided in the Monetary Policy Report.

The downward revision of Canadian growth and the upward revision of inflation for the year can be interpreted as a direct consequence of weak productivity growth rather than a reaction to a measure. The data also point to acute disinflation in the goods sector and reflation in the services sector, contrary to previously reported. Moreover, if the only factor explaining disinflation in Canada lies in goods inflation, we can’t assert with certainty that monetary policy has had the intended impact.

These discrepancies may be explained by the Bank of Canada’s reliance on a pre-covid framework, given that certain economic dynamics have changed since the pandemic. The Bank could reduce its rate a little further, but inflation data might act as a deterrent.