There was little surprise in the Bank of Canada’s announcement on Wednesday when the central bank reduced its policy rate by 25 basis points to 4.5 per cent.
The tone of the central bank’s statement was notably dovish and marked a departure from a hawkish or cautionary tone that persisted over the past two years.
The central bank acknowledged Canada’s lackluster growth, which is in line with the global economy amid a globally restrictive rate environment. Excess supply will not be fully absorbed until 2026.
With widespread disinflation and rising unemployment, our estimates show that the policy rate is still a percentage point too high. Canada’s soft landing could turn hard unless the Bank of Canada continues easing rates.
We expect two more rate cuts this year, of 25 basis points each, to end the year at 4 per cent.
Growth can resume only with more rate cuts, which are reasonable to expect. But central bank officials are not in a hurry because they do not want to reignite inflation; for this reason, a gradual series of cuts is still in order.
By now, disinflation is broad-based. Measures of core inflation have consistently stayed below 3 per cent. Excluding shelter, inflation has been under 2 per cent for half a year, well below pre-pandemic figures.
While there will be some bumps along the way because of base-year effects and wage growth, inflation is expected to return to 2 per cent next year.
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In addition, inflation expectations among both consumers and businesses have declined. Businesses’ inflation expectations are now in the Bank of Canada’s inflation-control range.
The Bank of Canada’s business outlook survey results are particularly telling. Businesses are no longer planning large price increases, and the labour shortage is easing, which suggests wage growth will moderate in the coming months.
What is concerning is the increase in the unemployment rate, which is largely because of a growth in the labour force from immigration and younger workers entering the job market rather than because of mass layoffs.
But if rates continue to stay high, households will rein in spending and business will reduce investments further, leading to layoffs and even more unemployment.
Household debt is the primary risk for the growth outlook over the next year. Easing monetary policy can bring some relief to households, especially homeowners whose mortgages were secured in 2020 and 2021 and will come up for renewals next year.
The takeaway
The shift in tone from the Bank of Canada signals that it expects more disinflation and further rate cuts, and that a recovery is on the horizon.
