taking the elevator up and the stairs down

This morning, the Bank of Canada opted to reduce its policy rate—after maintaining it at its highest level in a generation for almost a full year—to 4.75%. The Bank noted that not only has headline CPI inflation eased to 2.7% most recently for April, but that their preferred measures of core inflation have continued to slow (and are all now below 3%). The Bank also noted that they have confidence that inflation will continue to move towards the 2% target, but cautioned that risks to the inflation outlook remain.

That the Bank only reduced its trend-setting rate by 25 basis points was expected and is a reflection of their inflation risk aversion—indeed, they will move incrementally as they continue to loosen monetary policy going forward, taking time to assess the results of the (cumulative) effect of rate cuts as they go.

This is likely the first of many 25-basis-point cuts from the Bank: 4.75% is still very restrictive and the Bank wants to return its policy rate to “neutral”, where it’s neither restrictive nor inflationary (in the range of 2.25%-3.25%) by the end of this cycle. 

For homeowners, the cost of borrowing is not only still very high, but an increasing number of Canadians are renewing their fixed-rate mortgages at higher rates than they are currently on. This means that future spending will be redirected to servicing what will be more costly mortgage debt in the months ahead. This is why it’s likely that recent downward trends in not only inflation, but also in retail spending and in the labour market, will continue in the near-term. As a result, we expect additional evidence to emerge in the coming months that will strongly support further rate cuts. The Bank’s next rate announcements are July 24th and September 5th.