Under pressure: Canada’s rate cuts and economic revival
On June 5, the Bank of Canada became the first central bank of the G7 countries to get moving with rate cuts post-COVID, in a move that was widely anticipated. As opined {{nofollow}}here, this rate cut was necessary to give an ailing Canadian economy a breath of fresh air.
Stagnant GDP growth amidst rising interest rates
Since the Bank of Canada began hiking interest rates in the first quarter of 2022, Canada's GDP growth has noticeably stalled. The aggressive monetary tightening aimed at curbing inflation has inadvertently pushed the economy into what can be described as a "recession per capita." While aggregate GDP figures may not reflect a severe downturn, when adjusted for population growth, the economic picture is less rosy.
Canada's demographic expansion, driven by robust immigration policies, has partly masked this underlying economic weakness. As the population grows, GDP figures are buoyed by the sheer increase in the number of consumers and workers, but on a per capita basis, economic activity has actually been negative in six of the past seven quarters.
The housing market conundrum
The strain on the housing market underscores the need for a nuanced approach to inflation measurement and monetary policy. Shelter inflation, driven by rising housing costs, has been a major component of overall inflation. However, using monetary policy—an inherently blunt tool—to address housing inflation can have widespread, often detrimental, economic effects.
Time for rate cuts
Given the current economic landscape, it is imperative that the Bank of Canada continues its march towards a neutral policy stance. The aggressive rate hikes have achieved their primary goal of curbing runaway inflation, but at a significant economic cost. It was past time for the Bank to pivot towards easing.
Now that this first cut is in the books, we are expecting a second rate cut at the next decision date, on July 24, and a total of four cuts for the year. This would bring the leading rate from 5% just recently to 4% by year-end.
Looking forward to 2025 and 2026, we believe it is reasonable to expect a steady pace of cuts towards the neutral rate (the rate at which the central has neither a foot on the breaks, nor the gas pedal), which stands at 2.75% according to the Bank of Canada (source).