The Bank of Canada held its policy rate at 5% at its meeting on Tuesday, as widely expected, while continuing its restrictive monetary policy of quantitative tightening.
The central bank made a marked shift in its statement, turning from a focus on inflation to one on growth with a decidedly dovish tone.
But the central bank made a marked shift in its statement, turning from a focus on inflation to one on growth with a decidedly dovish tone.
The Bank of Canada is taking the cautious approach in waiting for evidence of sustained downward momentum in inflation. We expect the first rate cut to come in June; waiting any longer would risk repeating the mistake made in 2022,m when waited too long to pivot its rates policy.
Even after rates begin to fall, they will remain restrictive because they will still be well above inflation for the remainder of the year and because of the lagged impact of rate changes.
In addition, we expect the terminal rate to be in the 3 per cent to 3.5 per cent range, which is higher than in the pre-pandemic era and reflective of the insufficient aggregate supply in the new global economy.
The growth outlook is improving both globally and in Canada, but this positive outlook hinges on central banks around the world cutting rates.
Financial conditions are improving. The global growth forecast has been revised up to 2.75 per cent this year and to 3 per cent next year and in 2026. The United States has been outperforming expectations, though the U.S. gross domestic product will most likely slow this year.
At home, growth is expected to improve in the second half of the year because of population growth and strong spending by households and governments. The federal government’s $2.4 billion commitment to investing in artificial intelligence will most likely bolster growth and productivity, which Canada desperately needs.
Inflation outlook
The inflation picture is improving: Overall inflation has slowed, and core inflation is steadily declining as well. More disinflation is in the picture given the weakening labour market at home and China’s export of low-priced goods abroad, which puts downward pressure on prices.
While price stability remains the central bank’s goal, the Bank of Canada is signaling a shift in priorities as inflation has eased. In the Bank of Canada’s statement, for example, inflation now appears toward the end.
Read more of RSM Canada’s insights on the economy and the middle market.
Now, headline inflation has fallen under 3%. All core measures of inflation have been steadily declining. Inflation excluding mortgage interest rates is already on target. Inflation expectations among businesses are also declining.
The central bank acknowledged that shelter inflation remains elevated, and that is driven partly by mortgage interest costs. The simple solution then is to lower the policy rate.
The takeaway
A restrictive monetary policy has restored price stability in Canada. With the labour market slowing, inflation easing and growth poised to take off once interest rates are cut, there is little reason to wait much longer to cut interest rates.
With this statement, the Bank of Canada has signaled that it is ready to take the foot off the brakes in June and cut its policy rate as long as job and inflation numbers progress as expected.
