The Bank of Canada is widely anticipated to announce a reduction in the key interest rate during its upcoming policy meeting on Wednesday. The move, expected to be a 25 basis point cut, comes amid a backdrop of soft economic data and moderated inflation, marking a significant shift in the central bank’s approach to monetary policy over the past year.
The latest GDP figures from Statistics Canada show that the economy grew by only 0.4% in the first quarter of 2024, following no change in the fourth quarter of 2023 (revised down from 0.2%). This modest growth was driven primarily by higher household spending on services, with slower inventory accumulations moderating overall growth. These figures bring Canada close to a technical recession, defined as two consecutive quarters of negative GDP growth.
https://www150.statcan.gc.ca/n1/daily-quotidien/240531/dq240531a-eng.htm
Inflation has been a central concern for the Bank of Canada, but recent figures have provided some relief. For the past four months, inflation has remained within the central bank’s target range, with April’s rate at 2.7%, the lowest in three years. This moderation in inflation, coupled with stagnant economic growth, has paved the way for a possible reduction in the key interest rate, which has held steady at 5% for almost a year. Now, economists largely agree that the current economic data justifies a rate cut.
The anticipated rate cut also carries significant political implications. Canadians’ concerns about affordability have been at the forefront of national discourse, with rising cost of living. A rate cut, though modest, could provide a psychological boost for consumers feeling the pinch of high costs. However, the impact on the broader economy and political landscape is complex. The timing of the Bank of Canada’s decision is particularly crucial for the Liberal Party. Last July’s rate increase was followed by a sharp decline in their polling numbers, giving the Conservative Party a significant lead. A rate cut might help the Liberals regain some ground, but the magnitude of relief felt by the public will be critical.
While a single rate cut may offer short-term relief, economists caution against expecting a series of cuts. Canada’s economic landscape is heavily influenced by the United States. The United States experienced a 1.3% increase in real GDP in the first quarter of 2024, down from a 3.4% increase in the fourth quarter of 2023. Therefore, the disparity in interest rates between Canada and the U.S. could lead to a weaker Canadian dollar, increasing the cost of imports and counteracting some of the benefits of lower rates. On the housing front, a 25 basis point reduction is unlikely to significantly improve affordability in the overheated market. For businesses, the recent capital gains tax increase remains a primary concern, overshadowing the potential benefits of lower borrowing costs.
https://www.bea.gov/data/gdp/gross-domestic-product
The central bank’s decision will undoubtedly be a pivotal moment, not just for financial markets but for everyday Canadians navigating a complex economic environment. Creating conditions that support economic stability remains a top priority, and the upcoming rate decision is a crucial part of that strategy.