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Essentials of Monetary Policy

The First Rate Cut May Not Be the Deepest but It Won’t Be the Last

June 5, 2024
Randall Bartlett
Senior Director of Canadian Economics

According to the Bank of Canada (BoC)

  • As was widely expected, the Bank cut the overnight policy rate by 25 basis points to 4.75% today. After remaining unchanged at 5.00% since July 2023, this is the first rate cut since the onset of the pandemic in March 2020.
  • To justify the rate cut, the Bank pointed to progress made on fighting inflation. According to the press release that accompanied the announcement, “With continued evidence that underlying inflation is easing, Governing Council agreed that monetary policy no longer needs to be as restrictive and reduced the policy interest rate by 25 basis points.”
  • In his press statement, Governor Tiff Macklem highlighted four inflation indicators, in particular, that have made material progress: headline CPI inflation; core inflation measured by median and trimmed mean (both year-over-year and on a 3-month moving average basis); and the proportion of CPI components increasing faster than 3%, which is now close to its historical mean. And we think there is room for headline inflation to come in even lower in the near term than Bank’s most recent projection (graph 1).
  • The lower real GDP growth prints at the end of 2023 and beginning of 2024 than the Bank of Canada was projecting also influenced the central bank’s decision (graph 2). Governor Macklem cited population gains outpacing hiring as well. This has allowed the supply of workers to catch up with job vacancies, helping still elevated wage growth to moderate gradually.   
  • While recent data has increased the Bank’s confidence that inflation will continue gradually moving toward its 2% target, risks to the inflation outlook remain. “Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”

Implications

Today’s interest rate announcement is no doubt music Canadians’ ears. While reducing the policy rate, as expected, the Bank provided guidance to the effect that this cut will only be the first and there will be more to come. Indeed, according to Governor Macklem, “With the economy in excess supply, there is room for growth even as inflation continues to recede.” How many rate cuts and how quickly they come will depend heavily on the data continuing to cooperate. Regardless, rates should move gradually lower as ongoing mortgage renewals and a slower pace of population growth weigh on economic activity, potentially to a greater degree than the Bank currently anticipates (graph 3). 

2024 Schedule of Central Bank Meetings

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