Bank of Canada Reduces Interest Rates and Forecasts a Worse Economy in 2024

For the second consecutive month, the Bank of Canada has decided to lower its key interest rate by 25 basis points, now standing at 4.5%. The bank also indicated that further decreases in borrowing costs could be expected if inflation continues to decrease as predicted.

The central bank maintained its policy rate at a historically high level of 5% for nearly a year in an effort to address the issue of elevated inflation.

On the other hand, the European Central Bank decided to maintain rates at their current level last week, following a reduction in June.

“We have growing assurance that the necessary components to restore inflation to its target level are in position,” stated Bank of Canada Governor Tiff Macklem during a press briefing. The BoC restated its expectation that inflation will reach its 2% target consistently by the second half of 2025.

The central bank revised its 2024 economic growth projection downward to a modest 1.2% from the previously anticipated 1.5% in April. This adjustment is partly due to households allocating a larger portion of their income towards debt repayment, resulting in reduced discretionary spending.

“The cautious tone in the releases suggests that officials are becoming increasingly concerned about the possibility of an economic downturn,” stated Royce Mendes, the head of macro strategy at Desjardins Group, in a report.

Following the announcement of the rate cut, the Canadian dollar experienced a further decline in value. The loonie traded down 0.06% to 1.3794 against the U.S. dollar, equivalent to 72.5 U.S. cents.

According to money markets, there is a high likelihood of the BoC reducing rates in its upcoming monetary policy decision on Sept. 4. They are also anticipating only one more decrease of 25 basis points this year, which would result in a policy rate of 4.25% by the end of the year.

Macklem indicated that the anticipated trajectory of the policy rate was downward, however, the bank did not have a predetermined course of action.

“It is logical to anticipate additional reductions, however, the timing will be contingent upon the information that is received.” “And most importantly, the insights provided by that data regarding the future direction of inflation,” he stated.

Concerns About Growth

Macklem informed reporters that there is a growing emphasis on the potential negative impacts on inflation in discussions surrounding monetary policy.

Inflation is being influenced by two conflicting factors – a sluggish economy that is exerting downward pressure, and the continued high prices of housing and services that are exerting upward pressure.

“We must carefully consider the possibility of inflation exceeding expectations, while also taking into account the possibility of a weaker economy and lower inflation,” Macklem expressed.

In June, there was a slight decrease in the annual consumer price increase, which dropped to 2.7%. The central bank’s core measures of inflation, which are closely monitored, also experienced a slight easing.

Economists expressed concern about the potential for a decline in economic growth in the upcoming months. They emphasised that such a slowdown might lead to further reductions in interest rates.

“The Bank of Canada appears to be shifting its focus towards certain areas of the economy that are not performing as strongly,” commented Andrew Kelvin, who leads the Canadian and global rates strategy team at TD Securities.

Kelvin anticipates additional rate reductions of 50 basis points before the end of the year.

In its latest Monetary Policy Report (MPR) published on Wednesday, the central bank forecasted a 2.6% inflation rate for this year and 2.4% for 2025.

The growth rate for the first quarter was only 1.7%, which fell significantly short of the central bank’s April forecast of 2.8%.

The Bank of Canada stated that there would be a rise in economic expansion during the latter part of 2024. Due to the reduction in borrowing costs, there will be an increase in exports and a rebound in household spending.

“Given the improving state of the economy, the surplus supply will be taken up in the coming year and throughout 2026,” expressed Macklem.

The Bank of Canada projected a slight decrease in growth for 2025, with expectations now at 2.1%, compared to the previous forecast of 2.2% in April. Anticipating an expansion of 2.6% by 2026.

When questioned about the timing of rate cuts by the central bank, Macklem expressed satisfaction with the current rate levels.