Bank of Canada lowers overnight interest rate to 3.75%

Stephen Meurice: The Bank of Canada has announced yet another interest rate cut, and this time, it’s a big one.

Tiff Macklem at press conference: Today, we lowered the policy rate by 50 basis points. This is our fourth consecutive decrease since June and brings our policy rate to 3.75%.

SM: That’s Bank of Canada Governor Tiff Macklem at his latest press conference announcing a cut that’s twice as large as the ones the central bank made in each of its three announcements since June. But, other than a welcome reduction in the cost of borrowing, what does this mean for Canadians and the economy? Here to break it down for us as always is Scotiabank’s Chief Economist, Jean-François Perrault. He’ll tell Armina Ligaya what this says about Canada’s battle with inflation, take stock of what effect the cuts have had so far and tell us what he thinks we might see in 2025. I’m Stephen Meurice and this is Perspectives. Now here’s Armina Ligaya.

Armina Ligaya: JF, welcome back, as always.

Jean-François Perrault: Well thanks Armina. It's a pleasure to talk with you.

AL: So we're chatting once again about the Bank of Canada's decision, but this time it is a jumbo 50 basis point cut. So, tell us, what were your thoughts when you heard the latest announcement?

JFP: Kind of conflicted, to be honest. I mean, we had shifted to a 50-basis point call a couple of weeks ago. So it was in line with our updated forecast in some sense. But we shifted to 50 because we thought that the governor was a little bit dovish and that he would rather be more cautious and cut by more than less. Not necessarily because we thought that that's what needed to happen. In fact, when we look at the economy, we're a little bit comforted by some of the things that we see, except for inflation, which is slowing, which is, I think the primary reason they cut by 50. But, you know, the message of cutting by 50 is a pretty is a pretty powerful one. I mean, there is the questions that we had with when the Fed moved by 50 basis points, like ‘Is there something that we're missing, something we're not understanding. Is the Bank of Canada surprised somehow at something?’ And it doesn't look like it's the case when you listen to him speak, because he had a press conference following that decision. It doesn't look like that's the case when you read the monetary policy report. But, it still kind of begs the question, you know, why rush into 50? Is there something that we're missing?

AL: Maybe you can help put a 50-basis point cut into context. How uncommon is that for the Bank of Canada?

JFP: I mean, it's reasonably uncommon. But then again, rate cycles are reasonably uncommon themselves. The Bank of Canada's not always raising or cutting interest rates. So there are cycles every once in a while. In the past, 50 basis point moves have been associated with special events of some sort: a financial crisis, wars, those kinds of things. So it's a little bit unusual to have a 50 basis points move at this point because there is no clear sign that the economy is slowing in any dramatic way. In fact, when we look at the Bank of Canada's forecast, they haven't really changed their forecast for growth, despite the fact that they've cut by 50 basis points. So, they happen. They're infrequent. They're usually accompanied with some kind of economic event that warrants more caution on the part of the central bank. And they did it this time.

AL: So why do you think the Bank of Canada felt comfortable to make this bigger cut? You had mentioned inflation as a driving factor. You also mentioned the Fed making a 50-basis point cut themselves, adding I guess a little bit more comfort. What do you think are the contributing factors, the signs, the data points that they're looking for that said, ‘Okay, this is the move to go with’?

JFP: It seems like it's largely about inflation. So the one thing that is a little bit weaker and in the economy relative to expectations – certainly our expectations and I think their expectations – was that  the most recent inflation report suggested total inflation of 1.6%, so below 2%. Now that's largely because of oil prices. So when you strip that out, you know, in the low twos still, but that's close enough to 2% for the governor to be confident that inflation is kind of reached where he wants it to be or on path for that. And that happened a little bit sooner than anticipated. So maybe, or at least our interpretation, and he's more or less said this in his communications, that this more positive environment on the inflation side has allowed them to cut a little bit more aggressively this time because they are closer to where they thought they would be on inflation control. Now, that's not to say that they're indicating they're going to cut by that amount going forward. He's been very clear that we shouldn't infer from the 50-basis point that they will do another 50-basis points down the line. Everything is data dependent, but I think it really hinges on this slightly more positive inflation outcome than folks generally expected, and that then they're being opportunistic by cutting 50 basis points to account for that.

AL: So, you mentioned you're conflicted. I guess the bigger question is, in your view, was this the right move?

JFP: I mean, we'll know in a year if it was right move or not. So the reason we're conflicted is it's clear the economy is weak right now, but it's weak by design. The Bank of Canada’s been raising rates to generate slower economic activity so that inflation would get under control. So the fact that we're seeing weakish growth now is not really a surprise. And in fact, as I said, the Bank of Canada hasn't really changed their views on growth, even though they've cut by 50-basis points, but we’re mindful of pent up demand, we’re mindful of how quickly the economy might respond to lower interest rates. And this is particularly true in the housing side where, of course, the housing market's been reasonably slow through the summer months as folks anticipated lower mortgage costs. So, were sitting on the sidelines. The housing market has turned around the last couple of months. And early indications in October is that it's accelerating. We know that there are some mortgage rule changes that come into effect in December, which will make mortgages more affordable, more available to first time homebuyers or folks essentially in the Toronto/Vancouver market that need an $1,000,000 and above home. So our fear is that if you cut rates a little bit too fast, that maybe you trigger a response, particularly in the housing market or rate sensitive parts of the economy that might imperil future rate cuts. You know, if the housing market turns around and explodes, we'll say roars back in the spring, that's something that is of meaningful consequence to inflation that comes to the economy. And we're just mindful of that, given what we know to be these very large and persistent imbalances between supply and demand on the housing side, which kind of is the tinder that might need a monetary spark, if you will, to come back into play.

AL: You touched a bit on what my next question was going to be, which is how Canadians will feel the impact of this rate cut on top of the three previous rate cuts. Obviously, it's pretty good news. Canadians have been feeling the pinch for some time. But maybe you can walk us through how consumers, businesses, homeowners and maybe perhaps even renters could feel the impact of this move.

JFP: Yeah I mean, listen, there's no question that for households lower interest rates is a good thing.  Everybody wants to pay lower prices for various things, and that includes credit. So, the 50-basis points is going to be felt in borrowing costs. It’s going to be felt in variable rate mortgages. It’s going to be felt in lines of credit. It’s going to be felt across a broad range of interest rate products for both households and businesses. So you're going to see lower borrowing costs as a result of that. That's good. That's great. That's obviously why the Bank of Canada is lowering rates because they want that to happen. The question is the extent to which that translates into lowering borrowing costs if you want to borrow at a bit of a longer-term maturity, so say you want to get a five-year mortgage. Well, five-year borrowing costs from the Government of Canada, for instance, or even the US government, which is pretty important in terms of setting those rates in Canada, have been rising for the last few weeks. So you've had this situation where short-term borrowing costs are coming down as the Bank of Canada cuts, whereas those longer-term rates are moving up. So there's really kind of a tradeoff to make in terms of how people might think about interest rates and how they want to borrow versus exposing yourself perhaps more to a variable rate product versus something that’s more fixed in that those fixed rates have not necessarily come down from the mortgage side, but because the funding costs are going up, there's a limited downside for those rates going forward. So, it just depends on people's preferences. And it's true for businesses as well. But the reality is that when you take a look at the broad set of interest rates and when you kind of add the short term and the longer term, there's no question that we are looking at lower borrowing costs in general for Canadians through at least the middle of next year. And on the business side, of course, lower interest rates help. I mean they are designed to help. But importantly, we tend to focus on the household side, you know, mortgage costs and lines of credit and all kinds of things. But at the end of the day, businesses are the ones that supply the goods and services that people need and people want. So, as you lower interest rates, as confidence returns, as the cost of capital comes down, as businesses feel more optimistic about the way forward, then of course you'd expect business investment to pick up, hiring to pick up, you would expect profitability to pick up. And again think of the economic cycle. We are at the early stages of the return to stronger growth and lower interest rates, and with that typically comes higher earnings on the part of firms and higher stock market valuations as the economy just starts to get into gear and businesses and households both start to reengage in a more meaningful way.

AL: In terms of timing, you said at least the middle of next year, but how long does it take for these cuts, even the previous cuts and this mega cut, to really work its way through the economy?

JFP: It takes a while. It takes 18 to 24 months on the way up for interest to have their maximum impact on the economy. It's same thing on the way down. So, the start of the easing process, it's of course freeing up some cash for households and businesses now. There'll be more and more cash freed up as those rates continue to fall. But it's a long-term process. It takes a long time for those rates to have an impact. So, we think they cut until the middle of next year. Hopefully that happens. But the impact of those cuts will continue to be felt well into 2026 and maybe even beyond that. So you're in the early stages of what we call the rate cycle. So, you're cutting interest rates and that will generate a response from the economy in Canada and elsewhere, because other countries are doing this as well, that takes quite a while to build to maximum impact.

AL: So, one of the things Governor Tiff Macklem said in the press conference was essentially the central bank's job has shifted away from lowering inflation to maintaining it around the target, he called it sticking the landing. But he also said that they're also worried about it being too high or too low. I guess I wanted you to help walk us through what are some of the risks that could drive inflation back up, even though we've gotten it down to 1.6%? And then also, on the other hand, what are the risks of it being too low? As good as that probably sounds to Canadians watching their wallets.

JFP: Yeah, I mean, let's start with the upside risks. We know, for instance, in Canada, wage growth remains pretty strong. It's in the 4 to 5% range looking at a broad range of wage measures. And that, of course, is incompatible with 2% inflation. Right. You can't expect business to keep giving significant wage increases without passing some of that on to the price of their products. So the expectation is that, as the economy continues to operate below potentials, which is what we expect for the next couple of quarters at least, that you generate a little bit more labour market slack. So that puts downward pressure on inflation. And that's partly why the unemployment rate increase that we've seen is important because it does provide a little bit of relief on the labour market, which should put downward pressure on wages, but that hasn't really happened yet. So, there's a risk there that as we go forward that wage growth doesn't moderate as much as we think should happen. And you're seeing this, for instance, in negotiated wage settlement where those wage settlements are extremely high. Now, that's only about 30% of the workforce, but still there’s kind of an indicative value there. So we worry about that kind of inflationary pressure. The other is, of course, related to housing and shelter, which have been a big contributor to the upside on inflation over the last few years. That's starting to moderate yo some extent, but that's in part because house price growth has kind of stabilized and rents have come down in some markets a little bit. If you have a rebound in the housing market, that's triggered by lower mortgage costs, the fear is that as you get into the spring, if that market picks up a lot and prices start to rise with that as well, then of course you have a stronger inflationary impulse in part because you've got strong growth, but also because the prices of those homes is rising as well. So those are the two main inflation risks we see to the upside. To the downside, they're really essentially focused on has the Bank of Canada been too slow to respond? And we don't think so. But, you know, if the economy is weaker than we think going forward – so for instance, if growth disappoints in third quarter, the fourth quarter or even into early next year, if policy is mis-calibrated and you get weaker growth, then you get weaker inflationary pressures and that puts downward pressure on inflation. So if we find ourselves in a world where inflation does fall to 1.5% or below, and again we don't think that's going to happen, but if that's where we land, it's probably then going to be because the Bank of Canada might have been too slow to respond to the weakness in the economy. That the engineered weakness was perhaps overly engineered. They engineered a little bit too much weakness. Now, again, that's not our base view. That's not how we think about things. But I think that would be the reason why, if you see weaker inflation, it's because we've probably kept rates too high, too long.

AL: So with those risks as the backdrop, what do you think Canadians can expect in December, the next decision from the Bank of Canada?

JFP: Listen, our view is the Bank of Canada cuts the next few meetings by 25-basis points at a time. So, gradual. Now we say that and you know, for instance, the Bank of Canada stopping cutting rates at about 3% around the middle of next year, so a series of a few more cuts. The challenge to that, setting aside inflation issues and whether they’ve over-stimulated or under-stimulated or housing market rebounds, is you've got the US election in between now and the next meeting. Or now and the middle of next year as well, which has the potential to be pretty consequential in inflation dynamics. Right? For instance if former President Trump wins, you have a person who's campaigning on raising tariffs. Now, tariffs are inflationary. Inflationary for the Americans, inflationary for us if we retaliate, they create a lot of uncertainty. So, we might find ourselves in a world as early as early November, where we've got to reassess a little bit, the balance of risks going forward or think about price pressures. Wonder if in fact, we have to start thinking about tariffs in the United States or elsewhere. So that has a potential to have a pretty significant impact on how we think about where rates need to go and how central banks think about inflationary pressures. So, there is that bridge we've got to cross before we get to December and they feel comfortable about moving 25 basis points or more or less, depending on how the data come out.

AL: And I'm wondering, from this, from your perspective, what is the outlook for the economy in 2025 with some of those factors in mind? And did we learn anything new from the Bank of Canada's forecast or any commentary in its monetary policy report?

JFP: Yeah so I don't think we learn anything new, and that's comforting. It's comforting. You know, the concern, one of the concerns I think we had and others had is if they go by 50, are they accompanying that with some change in the perspective of are they informing us that they're seeing some additional weakness there, that is kind of escaping us and that wasn't the case. They cut by 50 largely said because inflation. They hadn't really changed their growth forecast. That's comforting. But as you think about next year, we are in the early stages of the rate cutting impacts, right? So rates have come down significantly so far this year. How the economy responds to that will be largely to 2025 and 2026 issues. So we would expect growth to pick up gradually as we go through next year and further into 2026. So you're almost certainly looking at a more positive environment next year than we've seen this year. So stronger growth, better employment outcomes, obviously, well-contained inflation and this would be true in Canada and it’d be true elsewhere in the world because other central banks are doing the same thing. So just a generally more positive economic environment in line with the typical cycle that we see with rates coming down, you know, combined with, you know, a reduction in uncertainty hopefully, and an increase in optimism with respect to the future prospects. Now that being said, there’s the U.S. election which will have a big impact on how we view those things. There will be a Canadian election at some point next year, which could impact how we think about the economy depending on platforms, depending on what is done pre-election by the Liberals. if they want to do something pre-election to, you know, solidify their chances of being re-elected or minimize their chances of losing. So there are uncertainties there. But generally speaking, you know, this is the time to start feeling a little bit better about the world. Rates are coming down, the expressed intent’s to lead to better and better economic outcomes next year in the year beyond that.

AL: So a lot of moving parts, a lot of different factors, but generally brighter economic path ahead.

JFP: We hope so. We hope so. And if it's not a bright economic path, then you would expect, we would expect rates to be much lower, or fall much more than to 3%.

AL: So before we wrap up here, what do you think are the three main takeaways for Canadians from the announcement?

JFP: Well, the first is, again, the governor is very clearly indicated that he will continue to cut interest rates. So that's not a surprise. But, you know, the more he says it, the more I think people need to believe that and plan around that. So that's clearly the case. The other is as we get greater certainty that rates come down – informed by the governor, in part – we have greater certainty that the economy will improve over the next year or so. So a better environment for Canadians to operate in. And that's, of course, occurring in an environment inflation is better controlled. So, you know, the price pressures that we've seen, the affordability challenges that we've seen coming from the price side of the economy will abate to some extent. And by ‘abate,’ I simply mean prices will rise by about 2% as opposed to falling. But that's a pretty good thing. So, I think we're on the right track. You know, the governor has talked about sticking the landing. It seems that we've, or they have achieved, or we collectively have achieved this kind of miraculous soft landing, which is, you know, rates have gone up just enough to slow inflation just enough for the economy to slow just enough without causing undue harm to both. And as we progress in time, we will have further and further evidence that we avoided a recession, hopefully, and that things aren't as bad as, you know, a lot of people fear that they are right now, feel that they are right now.

AL: I think that's a great place to leave it. Thank you, JF, once again for coming back on the show to break it all down for us.

JFP: Well, thank you. It's a pleasure.

AL: I’ve been speaking with Jean-François Perrault, the Chief Economist at Scotiabank.