Did the Bank of Canada Need to Act So Fast?

Did the Bank of Canada Need to Act So Fast?

Published on: June 6, 2024

Category: InsightsNews

The Bank of Canada cut its policy rate for the first time in four years on Wednesday, reducing it by 25 basis points to 4.75%. The overnight rate had held steady at 5% since July 2023, following 10 increases by the central bank starting in early 2022 to tackle inflation.

The Bank of Canada’s governor, Tiff Macklem, said that its Governing Council decided that “monetary policy no longer needs to be as restrictive.” He added that “our confidence that inflation will continue to move closer to the 2% target has increased over recent months.” During a press conference, Macklem said that if inflation continued to ease, it would be reasonable to expect further cuts.

Here are points made by the Bank of Canada in the press release following its decision on June 5, 2024:

• Canadian economic growth resumed in the first quarter of 2024 (+1.7%) after losing steam in the second half of 2023. However, growth was weaker than forecast in the Bank’s latest Monetary Policy Report, published in April 2024.
• Consumption growth was “solid” (about 3%), with the central bank noting that business investment and housing activity also increased.
• Businesses continue to hire, according to labour market data. However, employment is growing at a slower pace than the working-age population.
• Despite wage pressures that remain, the central bank said they look to be “moderating gradually.”
• According to the Bank of Canada’s assessment, the economy is still operating in excess supply.

The 25-basis-point cut in the policy rate came as a surprise to those that did not see the urgency for one.

Canada’s consumer price index dropped to 2.7% in April 2024, down from 2.9% in March. However, recent indicators have shown a clear acceleration in domestic demand. Consumption growth has exceeded 3% in the last two quarters. In particular, services consumption has been strong and real personal disposable income reached 6.0% in the first quarter of 2024. Moreover, based on household surveys, employment this side of the border is now growing faster than in the US.

Since the economy was already improving from a cyclical point of view, Wednesday’s cut seemed to have been motivated by recent inflation numbers. That said, given the weak productivity performance and high wage growth, the sharp rise in unit labour costs poses a reflation risk.