The Bank of Canada recently announced a reduction in its benchmark interest rate, setting the target for the overnight rate at 3.75%. Simultaneously, the Bank Rate now stands at 4%, while the deposit rate mirrors the new target at 3.75%. This move is part of the central bank’s broader monetary strategy, aimed at stabilizing inflation and fostering sustainable growth. Alongside rate adjustments, the Bank reaffirmed its commitment to balance sheet normalization—a process designed to reduce the extraordinary levels of liquidity that were injected into the financial system during recent economic downturns.
In this blog, we break down the key elements of the Bank’s decision and explore the economic context in Canada and abroad. We’ll also examine how the rate change could impact inflation, employment, and business activity moving forward.
Global Economic Landscape: Recovery with Divergent Trends
The Bank of Canada continues to expect the global economy to grow at an average pace of approximately 3% over the next two years. However, the recovery path is not uniform across key economic regions:
- United States: The American economy is expected to outperform earlier projections, driven by stronger consumer demand and labor market resilience.
- China: On the other hand, China’s economic outlook remains more subdued, reflecting challenges such as a sluggish real estate sector and soft domestic demand.
- Eurozone: Growth across the euro area has been weaker, but signs point to a modest rebound next year as inflation pressures ease and fiscal policies support demand.
Global financial markets have responded to expectations of lower policy interest rates, leading to more relaxed financial conditions compared to the summer months. Oil prices, an important global economic driver, have also softened by about $10 per barrel since the July Monetary Policy Report (MPR), further easing inflationary pressure.
Canadian Economic Outlook: Moderate Growth, Employment Challenges
The Canadian economy has shown steady but modest growth, expanding at a pace of approximately 2% in the first half of the year. The Bank projects growth to slow slightly to 1.75% for the second half of the year. Several key trends are shaping the Canadian economic environment:
- Consumer Spending: While overall consumption remains positive, spending per capita has begun to decline, suggesting some caution among households.
- Export Growth: The recent activation of the Trans Mountain pipeline expansion has given a boost to Canadian exports, particularly in the energy sector.
- Labour Market: The employment situation remains a concern, with the unemployment rate rising to 6.5% in September. Strong population growth, driven by immigration, has increased the labor supply. However, job creation has not kept pace, affecting young workers and newcomers the most. Additionally, wage growth continues to outstrip productivity gains, further complicating the economic landscape.
Despite the economic headwinds, the Bank of Canada projects that growth will gradually improve over the coming years, supported by falling interest rates, an uptick in per capita consumer spending, and a cooling labor market.
Growth Forecast: Optimistic Yet Measured
The Bank’s medium-term outlook suggests moderate but improving growth. As interest rates decline, consumer activity is expected to pick up, leading to stronger demand for housing and increased investment in renovations. Business investment is also projected to recover as companies respond to heightened demand, while exports remain strong thanks to favorable conditions in the United States.
Here’s a breakdown of the Bank’s GDP growth forecast:
- 2024: 1.2%
- 2025: 2.1%
- 2026: 2.3%
As the economy gradually strengthens, the excess supply that has built up in recent quarters is expected to diminish, paving the way for more sustainable economic expansion.
Inflation Trends: Targeting Stability at 2%
Inflation, a key focus of the Bank’s monetary policy, has seen significant improvement. The Consumer Price Index (CPI) inflation rate dropped from 2.7% in June to 1.6% in September, indicating that earlier rate hikes are starting to take effect. However, inflationary pressures persist in some sectors, particularly in shelter costs, though they have begun to ease.
Other key contributors to the inflation slowdown include:
- Falling Global Oil Prices: Lower oil prices have translated into reduced gasoline costs for Canadian consumers.
- Weaker Demand for Goods and Services: Excess supply in various sectors has exerted downward pressure on prices.
With the Bank’s core inflation measures falling below 2.5%, inflation expectations among businesses and consumers have become more stable. As the supply-demand balance in the economy normalizes, inflation is expected to remain close to the Bank’s 2% target over the medium term.
Rationale Behind the Rate Cut
The decision to lower the overnight rate by 50 basis points reflects the Bank’s desire to support economic growth while ensuring inflation remains within the 1% to 3% target range. Lowering interest rates is expected to stimulate borrowing and spending, helping to absorb the economy’s excess supply and sustain business investment.
Looking ahead, the Bank has signaled the possibility of further rate reductions, provided that economic conditions evolve as anticipated. However, any additional rate adjustments will be carefully calibrated based on incoming data and their potential impact on inflation expectations.
Impact on Key Sectors
- Housing Market
The real estate market is expected to benefit from the reduced interest rates, with increased housing demand likely to drive sales and renovation activity. This should offer a reprieve to the sector, which has experienced some cooling due to previous rate hikes. - Consumers
Lower interest rates mean reduced borrowing costs, which could encourage consumer spending. However, households must remain cautious given that wage growth may continue to lag behind productivity improvements. - Businesses
For businesses, the rate cut offers an opportunity to access more affordable credit, potentially boosting investment in growth initiatives. Stronger demand from both domestic and international markets—particularly the U.S.—should further support business expansion. - Employment
Although the labour market remains soft, the Bank’s rate reduction could have a positive impact by spurring business investment and job creation. Still, challenges remain, particularly for younger workers and new immigrants, who have been disproportionately affected by labor market slack.
Monetary Policy Going Forward
The Bank of Canada has emphasized that future rate decisions will be data-driven and carefully assessed on a meeting-by-meeting basis. While the recent rate cut reflects confidence in the economy’s gradual recovery, the Bank remains committed to its primary mandate of maintaining price stability.
If the economy performs in line with the Bank’s projections, further rate reductions are likely. However, the pace and timing of these cuts will depend on the evolving economic landscape, particularly with regard to inflationary pressures and labour market dynamics.
Next Key Dates
The Bank’s next scheduled policy announcement will take place on December 11, 2024. Additionally, the Bank will publish its next full economic outlook, including inflation forecasts and risk assessments, in the Monetary Policy Report on January 29, 2025.
Conclusion
The Bank of Canada’s decision to reduce the overnight rate to 3.75% marks a significant shift in monetary policy, reflecting the need to balance economic growth with price stability. While the move offers hope for stronger growth and improved labor market conditions, challenges remain, particularly in addressing wage-productivity gaps and ensuring sustainable consumer spending.
By signaling the possibility of further rate cuts, the Bank has provided a level of reassurance to markets and consumers alike. However, with future decisions resting on evolving economic data, policymakers will need to navigate carefully to maintain the delicate balance between growth and inflation.
As we move closer to 2025, it will be crucial to monitor how key sectors respond to the new interest rate environment and whether the Bank’s projections align with actual economic performance. Stay tuned for the next policy update in December, which will offer further insights into the trajectory of the Canadian economy.