Policy Rate Cut: Bank of Canada Stands Firm Despite Looming Signs of Reflation

Policy Rate Cut: Bank of Canada Stands Firm Despite Looming Signs of Reflation

Published on: December 13, 2024

Category: InsightsNews

As expected by market observers, the Bank of Canada (BoC) announced a further 50 basis point cut in its policy rate on Wednesday, bringing it to 3.25%. This is the second consecutive 50-point cut since October. The BoC cut its rates by a total of 1.75 basis points over the last six months.

The Central Bank stated that its decision was motivated by evidence that the economy was in a situation of excess supply and by the observation that recent indicators were pointing to weaker than expected growth. In a press briefing, Governor Tiff Macklem said, “We anticipate a more gradual approach to monetary policy if the economy evolves broadly as expected.”

Here are a few observations made by the Bank of Canada in the press release issued following its December 11 decision: 

• The Canadian economy grew by 1% in the third quarter 

• CPI inflation has stood at around 2% since the summer 

• GDP growth in the third quarter was dragged down by business investment, inventories and exports 

• The unemployment rate rose to 6.8% in November 

• The Canadian dollar fell against the general strength of the US dollar

In light of these insights, it is worth noting that the BoC has never cut its policy rate so quickly outside a period of recession or a major terms-of-trade shock. The federal government’s temporary tax cut is likely to delay reflation in Canada by about a month next year, but what follows remains unclear. This pace of rate cuts seems too swift to completely rule out the risk of reflation in the future, given the particularly poor productivity performance of the Canadian economy.

The Central Bank also seems to assume that a certain labour market gap caused by an increase in labour supply is equivalent to an economy shedding jobs. A strong influx into the labour market will obviously lead to a rise in the unemployment rate. However, cutting the key rate too aggressively is unlikely to bring the unemployment rate down quickly. Only time will allow these new jobseekers to be integrated into the labour market.

By justifying its cuts on the grounds of an easing labour market and excess supply, while ignoring structural changes in population growth, the BoC is opening the door to policy missteps, which could increase the risks of reflation.