As we expected, the Bank of Canada pulled the trigger for the second month in a row, lowering its policy rate from 4.75% to 4.5%. The market, which fully priced in a cut, also got it right.

In today’s announcement, the Bank of Canada sounded more confident that inflation is trending in the right direction. The Bank talked about “signs of slack in the labour market,” “excess supply,” and how “broad inflationary pressures are easing.”

The Bank has been in ‘wait and see’, data dependent mode. So let’s recap some of the data since June that in our view supported today’s cut: 1) the annual inflation rate fell from 2.9% in May to 2.7% in June, marking the sixth month in a row that inflation has held in the 1-3% control range; 2) the latest jobs report showed the unemployment rate rising to 6.4% in June; 3) last week’s retail sales numbers posted another decline; and 4) indications that short-term consumer inflation expectations are falling.

The data point that likely sealed the deal was June’s inflation number. An uptick in inflation would have made a cut much more challenging to communicate.

If there was any hesitation and debate in the Bank, it may have come from sticky core inflation (edging higher on a three-month moving average basis) and the combo of high wage growth/weak productivity. The Bank noted that wage growth is elevated and the challenges this poses for service inflation in particular. But it also suggested these wage pressures are easing.

Overall, the Bank found enough evidence that inflation is moving in the right direction. Just like his U.S. counterpart Jerome Powell in recent days, Tiff Macklem sounded more confident today. In fact, Macklem even talked about inflation falling too much. This is the key paragraph from the press conference that conveys more dovish confidence:

“In recent months, we have continued to make progress bringing inflation down. With the target in sight and more excess supply in the economy, the downside risks are taking on increased weight in our monetary policy deliberations. We need growth to pick up so inflation does not fall too much, even as we work to get inflation down to the 2% target.”

The Monetary Policy Report (MPR) provided a fresh set of projections—something that happens four times a year. It’s not as cheery as last week’s International Monetary Fund real GDP forecast (1.3% in 2024, 2.4% in 2025) and slightly below the Bank’s April expectations. The updated forecast is 1.2% in 2024 and 2.1% in 2025, closely aligned with our own. The inflation forecast didn’t change much from April, holding at 2.6% in 2024 and up a tad in 2025 at 2.4%.

Closer to home, the Bank noted that export growth will be led by oil production, with new capacity coming online from the Trans Mountain Expansion (TMX). Sound familiar? Oil exports are a major growth driver in our latest Alberta Economic Outlook. The Bank also noted that this additional egress should lead “businesses to increase investment in oil and gas production.”

The key thing in the MPR is that the Bank talks about more excess supply in the economy than previously expected: “excess supply is expected to be slightly larger over the course of the projection horizon.” This points to less underlying inflationary pressures. The Bank notes that excess supply will be gradually absorbed, in part because new limits on temporary residents will slow population growth in 2025.

The MPR now says that they are expecting Canada to “sustainably reach the 2% target in the second half of 2025,” a slightly stronger tone than “near the end of 2025” in its April assessment.

Of course, there is always the risk that inflation could reignite with a slightly looser monetary policy. The Bank of Canada talks about geopolitical developments and service price inflation as the main upside risks. But these risks need to be carefully balanced against the risk of the economy tipping into a recession, inflicting more damage than necessary to get inflation back to 2%. Even as rates grind lower, monetary policy remains restrictive. Consumers will still reset at higher rates and longer term loans already reflect rate cut expectations. The economy is expected to hobble along before a meaningful improvement later this year and next year. And once the dust settles, the landing spot for the policy rate is closer to 3%, not returning to near zero from before.

To recap, the Bank is still in the early innings of unwinding its rate hikes, after the most aggressive rate hiking cycle since the early 1990s. The Bank of Canada raised its policy rate from 0.25% in February 2022 to 5% in July 2023 (where it stayed until June 2024).

Our quick take: The right call for the moment—an economy now struggling from previous rate hikes and evidence that inflation pressures are easing.

Monetary policy is often said to be a blunt instrument—it cannot solve all economic problems (including Canada’s sluggish productivity). But given what the Bank has to work with, another cut is the right medicine. This move will help variable rate borrowers, but won’t suddenly restore affordability. The main thing it does is help improve confidence, providing a signal that the inflation problem is moving closer to the rearview mirror.

In short, a step in the right direction on the long and bumpy road back to ‘normal’.

Answer to the previous trivia question: The dot-com bubble began to burst in 2000 with the NASDAQ falling from 5,048 in March 2000 to 1,139 in October 2002.

Today’s trivia question: How many people sit on the Governing Council of the Bank of Canada?