Businesses and Consumers Won’t Get Much Relief until Interest Rates Fall Further

Well, it happened. After watching interest rates spike, consumers are finally catching a break, with some central banks recently starting their rate cutting cycle. Among advanced economies, Canada, the eurozone, Switzerland and Sweden have begun to loosen monetary policy. The Bank of Canada (BoC) lowered its target for the overnight rate from 5.00% to 4.75% on June 5. But despite this initial cut, Canadian monetary policy remains very restrictive, and additional reductions will be needed to gradually bring rates closer to neutral (about 2.75%). If inflation continues to come down in Canada, we expect three more cuts by the end of the year, followed by further loosening in 2025 and 2026. We see the BoC’s target for the overnight rate eventually falling to about 2.25% by early 2026.

In the US, the Federal Reserve (Fed) will have to wait longer before starting to cut rates. Demand there has been more resilient, and there’s still some upward pressure on inflation. For example, per capita consumer spending growth is stronger than in most other industrialized countries (graph 1). This is likely due in large part to mortgage terms, which are longer in the United States than in countries like Canada and the United Kingdom. It’s also why interest rate hikes don’t have as much of an immediate impact in the US. Investment continues to rise as well, especially in the manufacturing sector (graph 2), as some US companies have started to reshore production—particularly chip manufacturing—to reduce their dependence on volatile global trade. We therefore expect the Fed to wait until its November meeting immediately following the presidential election to announce its first interest rate cut.

It remains to be seen how far the BoC will diverge from the Fed on monetary policy. The fear is that the Canadian dollar will plummet, potentially pushing up import prices and putting renewed upward pressure on inflation. But our estimates suggest the BoC has some room to pursue its own monetary policy. On the one hand, interest rate spreads aren’t the only factor driving the CAD exchange rate, and our forecasts see the Canadian dollar depreciating just slightly over the coming months. On the other hand, import prices don’t show up in consumer prices right away, and consumer prices won’t move much if the exchange rate doesn’t.

Lower interest rates will impact businesses and consumers around the world to varying degrees over the coming quarters. Our forecasts for Canada and Quebec haven’t changed much, and we’re still expecting economic growth to pick up in 2024. But the booming population, which has been a major driver of Canada’s economic growth in recent quarters, is expected to slow as new caps on non-permanent resident admissions take effect this fall. This could offset some of the positive effects of lower interest rates and result in new labour shortages in some sectors.