The market is abuzz with anticipation as the Bank of Canada prepares to announce its latest interest rate decision on Wednesday. While there is broad agreement that the Bank of Canada will cut rates for the fourth consecutive meeting, the key question on everyone's mind is how much? Forecasters are predicting a jumbo half-percentage-point move, a marked departure from the cautious quarter-percentage-point cuts seen in the past. This would not be unprecedented, as similar-sized cuts have been witnessed in the past, but the market is now convinced that a larger cut is necessary to address the evolving economic landscape.
The Bank of Canada has been criticized for being too slow to react to the changing conditions in the economy. Some argue that a more aggressive approach is necessary to combat the risk of deflation. The inflation dragon that most global central banks worried about has already been slain, especially in Canada. Headline inflation was a mere 1.6 per cent in September, below the 2-per-cent midpoint of the Bank of Canada’s target range, while core inflation looks likely to follow soon. However, housing is now the only major component of the Consumer Price Index (CPI) putting upward pressure on overall inflation.
Real estate data companies are reporting a significant cooling in rent growth. For example, Canada’s average asking apartment rent grew by just 3 per cent in the third quarter compared to the previous year, well below the 10-per-cent peak growth rate in early 2023. The Bank of Canada should fully discount the distorted impact of housing costs. By doing so, inflation is just 0.4 per cent as of September. This is not only well below the Bank of Canada’s target range, but puts the country at risk of deflation.
In addition to the low inflation rate, the Canadian economy is also facing other headwinds. Economic growth for the third quarter was below the Bank of Canada’s estimates. Although growth in real gross domestic product (GDP) remains positive and has defied the traditional definition of recession (two consecutive quarters of negative growth), its positive performance is largely due to surging population growth, which will likely reverse going forward. Moreover, in per capita terms, real GDP growth has declined for several consecutive quarters. As a result, Canadians likely feel like the country has been in a recession for years.
With inflation dead, Canada’s economy is in need of sharper interest-rate cuts. To get ahead of the curve, the Bank of Canada should consider even bigger cuts than half a percentage point. This would help to get interest rates back down to neutral levels faster. The central bank’s interest rate announcement on Wednesday comes after Statistics Canada reported the annual inflation rate in September tumbled to 1.6 per cent — below the Bank of Canada's two per cent inflation target. The sharp slowdown in inflation this year has come as somewhat of a surprise for economists who feared price growth might take longer to tame. Now, the Bank of Canada is contending with the risk that interest rates may actually restrain economic growth by more than desired.
The Bank of Canada has lowered its key interest rate three times so far, bringing it down to 4.25 per cent. The gloomy economic backdrop paired with plummeting inflation have many forecasters convinced that the Bank of Canada will deliver back-to-back jumbo interest rate cuts in both October and December, which would bring its policy rate down to 3.25 per cent. The parliamentary budget officer projected in its recent economic and fiscal outlook that the central bank will continue cutting rates until its policy rate reaches 2.75 per cent in the second quarter of 2025.
Carl Gomez, chief economist at real estate data company CoStar, said real interest rates in Canada — which are adjusted for inflation — are much higher than in other countries, putting more downward pressure on the Canadian economy. The U.S. annual inflation rate fell to 2.4 per cent in September while the Federal Reserve's policy rate sits at 4.75 to five per cent. The Bank of Canada's interest rate cuts were expected to stimulate activity in the housing market again, raising fears that inflation could rebound. But Gomez said that while home listings have increased, demand in the housing market is still tepid.
The central bank's interest rate announcement on Wednesday will be closely watched by economists and investors alike. The decision will have a significant impact on the Canadian economy and could also influence the direction of the Canadian dollar. The Bank of Canada’s policy decision will be announced at 13:45 GMT on Wednesday, followed by a press conference from Governor Macklem at 14:30 GMT.
The Big Picture: Why a Supersized Rate Cut is Needed
The Bank of Canada’s rate decision this week will be a significant event for the Canadian economy. The central bank is facing a difficult challenge in navigating the delicate balance between taming inflation and supporting economic growth. With inflation now firmly under control and the Canadian economy facing significant headwinds, a supersized rate cut is the right move to help restore economic momentum. The Bank of Canada needs to act decisively to avoid being left behind the curve and to ensure that Canada does not fall into a deflationary spiral.
What’s Next for the Canadian Economy?
The Bank of Canada’s interest rate decision this week will be a key indicator of the central bank’s future course. If the bank delivers a supersized rate cut as expected, it will signal that it is committed to supporting economic growth and that it is willing to take more aggressive action to address the challenges facing the Canadian economy. The market will be watching closely to see how the central bank communicates its decision and what it has to say about the future outlook for the Canadian economy.
