Bank of Canada Cuts Policy Rate by 50bps to 3.75%. Hints at More Easing.

In an effort to boost economic activity and maintain inflation close to the 2% target, the Bank of Canada (BOC) lowered its key policy rate by 50 basis points to 3.75% Wednesday, in line with market expectations.

Governor Tiff Macklem said there was a "clear consensus" that 50 basis points was appropriate.At 3.75%, the target for the overnight rate remains restrictive when compared to the neutral rate estimated to be between 2.25% and 3.25% in Canada.

As it sees the risks to the inflation outlook as balanced, the central bank hinted at further rate cuts should the economy evolve as expected, although it reiterated that the timing and pace will remain data dependent.

Several factors led the BOC to go for a 50bp rate cut:

- Headline inflation is down to 1.6%.

- Core inflation is also slowing.

- Shelter prices remain elevated but are coming off, and the central bank said it is more confident now that this trend will continue.

- There is still excess supply in the economy.

- The labor market is "soft" despite still elevated wage growth.

- Consumer and business inflation expectations have also come down.

So overall the central bank is more confident now that Canada is back in a low inflation environment, and can focus on keeping inflation stable. But given that the economy is still in excess supply, this requires rate cuts.

The central bank expects real GDP growth to slow to 1.75% in the seconf half of this year, from 2% in the first half even though the annualized GDP rate is expected to pick up to 2.0% in the fourth quarter.

For 2024 and 2025, the BOC left its growth projections unchanged at 1.2% and 2.1%, respectively. These forecasts are slightly below the International Monetary Fund's projections.

Population growth has been a key driver of GDP expansion in Canada. When adjusting for this factor, GDP per capita actually contracted for a fifth consecutive time in the second quarter, illustrating the weakness of activity. Going forward, tightening immigration policy is likely to remove support coming from population growth. Starting in 2025, however, the BOC expects GDP per capita to start picking up.

Source: Bank of Canada October 2024 Monetary Policy Report

Canada's inflation rate fell to 1.6% in September. "We're back to low inflation," said Macklem, expecting inflation to remain close to target going forward, which would leave room for further rate cuts to boost the economy.

The BOC expects the 12-month inflation rate to average 2.1% in the fourth quarter, the same as in the third quarter. Core inflation, which currently remains slightly above 2%, is also projected to reach 2% over the projection period through 2026. Both the IMF and the PBO expect inflation to undershoot in 2025.

Source: Bank of Canada

The bank has one more meeting scheduled for December 11. If the economy evolves as the BOC expects, more rate cuts are likely as soon as December. TD Economist Rishi Sondhi predicts that one more cut will happen this year, with further cuts expected next year.

Continued rate cuts will support the housing market, especially when combined with the easing of mortgage rules. That being said, potential homebuyers could remain on the sideline until rates come down further, which would delay the pickup in housing activity.