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Essentials of Monetary Policy

No Surprises in the Bank’s Latest Rate Decision as Economic Slack Continues to Bring Down Inflation

September 4, 2024
Randall Bartlett
Senior Director of Canadian Economics

According to the Bank of Canada (BoC)

  • As was widely expected, the BoC cut the overnight policy rate by 25 basis points to 4.25% today. This is the third consecutive rate cut of the same size since they began in June, after the policy rate reached a peak of 5.00% in July 2023. The Bank also left its quantitative tightening program unchanged.
  • To justify the rate cut, the Bank pointed to ongoing progress made on fighting inflation. According to the press release External link. that accompanied the announcement, “With continued easing in broad inflationary pressures, Governing Council decided to reduce the policy interest rate by a further 25 basis points.”
  • In his press conference opening statement External link., Bank of Canada Governor Tiff Macklem further emphasized that the decision reflected two main considerations. The first is that headline and core inflation have continued to ease as expected. The second is that Governing Council wants to see economic growth pick up to absorb the slack in the economy as inflation gets closer to the 2% target. Importantly, according to Governor Macklem, “If inflation continues to ease broadly in line with our July forecast, it is reasonable to expect further cuts in our policy rate.” And so far, inflation is easing in line with the Bank’s latest forecast, and we expect that to continue (graph 1).
  • Notably, Governor Macklem recognized that while growth came in somewhat stronger in the first half of 2024 than expected in July, there is downside risk to the Bank’s extremely optimistic outlook for Q3 real GDP growth (graph 2). Indeed, our tracking so far in the third quarter is about half the 2.8% annualized pace published in the July 2024 Monetary Policy Report (MPR). This suggests to us that the Bank may be estimating more slack in the Canadian economy than it had been assuming in July. This is happening in a context where inflation is closing in on the target, prompting Macklem to warn about the “need to increasingly guard against the risk that the economy is too weak and inflation falls too much.”
  • Notably, while Governor Macklem did mention the Canadian labour market in his opening statement, he emphasized that recent weakness was concentrated in youth and newcomers, and reflected soft hiring as opposed to business layoffs. “The slack in the labour market is expected to slow wage growth, which remains elevated relative to productivity.” This should further support a reduced pace of services and core inflation.

Implications

While today’s rate cut didn’t come as a surprise and still isn’t enough to spur a recovery in the economy, the guidance on future rate decisions, conditional on inflation, suggests that policymakers are ready to continue easing policy. Indeed, we’re of the view that the economy is likely to underperform the Bank’s optimistic July outlook and pull inflation lower than the BoC’s projection as a result (graph 3). While this may increase the chances of an accelerated pace of rate cuts, our base case forecast still sees 25 basis point rate reductions in October and December of this year, and six more in 2025.

2024 Schedule of Central Bank Meetings

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