Today’s decision by the Bank of Canada to lower its policy rate by 25 basis points to 4.25% was not a surprise. A cut was widely expected (including by us)—the only mystery was whether they would go big with a 50-basis point cut.

A case could have been made for a larger cut given the sluggish economy and cooperating inflation. But the Bank likely concluded that conditions haven't deteriorated to the point to warrant a super-sized cut (and may not have wanted to send that emergency signal).

We don’t have a new economic outlook to analyze (that comes in October). So we’re left dissecting a fairly short statement along with press conference comments.

In our judgment, the language more or less follows a similar tone laid out in July (see the table comparing the two announcements at the end of today's Twenty-Four). The Bank of Canada is more confident about the downward inflation trend, will continue to lower rates as long as inflation continues to cooperate, and is more attuned to downside economic risks.

A few noteworthy points:

• In the press conference, Governor Tiff Macklem kept in the language from the July press conference about inflation falling too much. While the Bank acknowledged the risk of inflation turning higher, it was balanced with this more dovish comment: “with inflation getting closer to the target, we need to increasingly guard against the risk that the economy is too weak and inflation falls too much."
• A key factor giving the Bank more confidence is not just that inflation is falling, but that it’s becoming more broad-based: the “share of components of the consumer price index growing above 3% is roughly at its historical norm.”
• On remaining inflationary pressures, the statement highlights that “wage growth remains elevated relative to productivity.” The Bank has been far from silent on Canada’s productivity struggles. Absent is a mention from the previous statement that wage growth is moderating, though Macklem said in the press conference that “slack in the labour market is expected to slow wage growth.” The combo of sticky wages and sluggish productivity is an obstacle to the 2% inflation target, along with some lingering shelter and service costs pressures.
• The Bank is clear that they will cut further if inflation cooperates. From the press conference: “If inflation continues to ease broadly in line with our July forecast, it is reasonable to expect further cuts in our policy rate.”

How did we get here? The July rate announcement and Monetary Policy Report turned the tide in our view. The Bank of Canada’s language has turned more dovish, warning more of downside risks, evidence that inflation is trending lower and that past rate hikes were slowing the economy. All this came after the most aggressive rate hiking cycle since the early 1990s when the Bank of Canada raised its policy rate from 0.25% in February 2022 to 5% in July 2023 (where it stayed until early June 2024).

Where to next? We see the Bank cutting its policy rate again by 25 basis points in each of its final two meetings or 2024—October and December—and four more times next year.

There are three main reasons for our view:

1. Inflation is falling

Remember Tiff Macklem’s “We have seen what we want to see. We just need to see it longer” commment from April, in reference to the falling inflation rate? The Bank did see it longer, leading to the three cuts. And today, there were more comments on inflation progress.

As for the actual inflation data, here is why the Bank may sound more confident:

• Inflation at 2.5% in July, the lowest since March 2021
• Inflation in its 1-3% control band every month this year
• Key core inflation measures now in the mid 2s year-over-year
• Shelter costs—the main outstanding inflation problem—rising at its slowest rate since in a year (5.7% y/y). Inflation excluding mortgage interest costs (itself influenced by the Bank of Canada) at 1.8%.

2. Canada’s economy is struggling to grow

Last week’s GDP report may have been better than expected, but it was weaker under the surface. Government spending was a key driver of the 2.1% annualized growth in the second quarter. More notably, per capita GDP has been falling and continues to diverge from the U.S.

The economy is clearly in excess supply mode, which is the central bank’s way of saying that the economy itself is no longer adding to upward inflationary pressures.

3. The labour market has softened

One of the inflation concerns raised by the Bank is stubborn wage pressures. In the past, this was driven by a tight labour market. Now the Canadian economy is not growing fast enough to absorb many new entrants into the labour market. The unemployment rate has risen 0.9 percentage points over the past year to 6.4%, with a particularly large increase among youth and newcomers to Canada. The annual pace of job growth has slowed, and the new jobs added have been concentrated in the public sector and among part-time employees. Reduced federal targets for non-permanent residents should slow labour force entry. But in the near term, we expect continued upward pressure on unemployment rates.

Implications: The Bank of Canada’s pivot to lower rates is, in large part, a response to a weaker Canadian economy. Even after interest rates return to ‘normal’, there are more structural growth challenges that lower interest rates can’t fix, not least of which is Canada’s languishing labour productivity. But the good news is lower borrowing costs, notably for those with variable rate loans. The rate pivot provides more confidence that the inflation problem is moving closer to the rear view mirror—providing a lift for consumers and businesses going into 2025.

Our quick take: The right call. The Bank of Canada is in its early innings of an easing cycle, and is becoming more confident that it can lower rates without reigniting inflation. With inflation pressures easing, we believe the Bank will keep the rate cutting streak alive, barring an inflation surprise. Our current forecast is for two more 25 basis point cuts this year, and four next year—bringing the policy rate to the mid-point of neutral (2.75%) by the end of 2025.

Answer to the previous trivia question: The diameter of the pipe used for the Trans Mountain Expansion Project ranges from 30 inches to 42 inches with the majority 36 inches.

Today’s trivia question: How many Bank of Canada Governors have there been (including the current Governor Tiff Macklem)?