In the end, it was an anti-climax. After months of speculation and conjecture, the Bank of Canada has reduced its benchmark interest rate for the second successive time. But the markets, which had already priced the cuts in, gave an indifferent shrug. A second cut is not expected to kick-start a rebound in house prices, placate those worried about mortgage renewals, or free up enough disposal income to fuel a significant uptick in economic growth. In Star Wars speak, it’s like waiting for the Prequel Trilogy, and then getting The Phantom Menace.
The champagne remains on ice then amid widespread acknowledgement that this is only the beginning. Of course, listening to Governor Tiff Macklem, that’s exactly where he wants it. The central bank knows it must balance its desire to get inflation down to its target 2% range without plunging the country into a damaging recession. The dovish statement that accompanied its latest decision was revealing. While warning that inflation (down in June to 2.7% from its 8.1% high in 2022) could rear its head again, it’s clear that after 10 interest rate increases in 2022 and 2023, the bank is more concerned it has slowed the economy down too much.
The trajectory for interest rates, therefore, is now likely to be down and the collective sigh of relief is audible. But despite the initial rate-cut salvo, Canada has barely started to turn the corner. So, are you a glass half full person or a glass half empty?
Reasons for optimism
It’s started. Finally. The much-anticipated loosening of monetary policy has arrived, even if the pace of it remains unclear. In March 2022 (not even two and half years ago), the key interest rate was 0.25% before rocketing to 5% by August 2023. Historically, that is low but compared to recent years, it feels mountainous. Reducing the benchmark rate to 4%, married with the bank’s dovish language, confirms a new cycle is well under way.
For more encouragement, you only need to look back to the last time interest rates were this high. As we entered 2001, the bank’s rate stood at 5.75%, having been as high as 6% in May 2000. Concerns about an overheating economic and worries about inflation were supercharged by the dotcom bubble and 9/11, which pushed an expected slowdown into a more stressful place. The Bank of Canada realized enough was enough and cut quickly. By February 2002, the benchmark rate was 2%. Different times, of course, but the takeaways are things can change quickly and no one knows what’s around the corner. Another geopolitical shock could easily speed up the rate-cut cycle.
Reasons for caution
Canada may have beaten the U.S. Federal Reserve to the punch, but Macklem admits there are limits to how far it can diverge from its southerly neighbours. Canada is, though, more confident about its ability to get inflation under control. In the U.S., amid unexpected economic resilience and robust consumer spending, inflation rose from 3.1% in January to 3.5% in March before sliding back to 3% in June. July’s figures will be available August 14. The U.S. rate cycle is clearly lagging Canada and with election uncertainty red hot, it’s unlikely the Fed will cut before September. This could weigh on Macklem’s desire to keep cutting.
Another reason why the response to the cuts has been muted might be that some experts believe it has come too late – even if the Bank of Canada cut at every meeting until the end of the year (three more times). As mentioned, the recent two rate cuts will likely have minimal impact on consumers’ balance sheets. In addition, real GDP per capita is sitting at 2017 levels while the recent Statistics Canada retail sales report – retail sales were down 0.8% (down in eight of nine sectors) and core retail sales were down 1.4% - strongly suggests people are feeling the pinch. Weak consumers are a major headwind for businesses, meaning the risk of a recession remains very real. Are we living in more challenging times than we think?
What next?
It’s important to stay informed of what is happening and how it might impact your investments and financial plan without sacrificing or deviating from your long-term plan and goals.
We are living in a different time to the post-financial crisis era of uber low rates - when a central bank meeting was as surprising as a Toronto Maple Leads playoff defeat. As welcome as the recent cuts were, along with the numerous think pieces demanding the Bank of Canada now cut like crazy, the mindset must be that inflation is unlikely to go down without a fight and that future cuts, as we’ve already seen in the U.S. may not happen as fast as you expect or want.
On a day-to-day level, mortgage renewals and household debt management should be top of mind. Despite the bank’s new direction, the impact of inflation will have cut into spending power and it’s vital to retirement plans, monthly cash flow and, importantly, your peace of mind that these are reviewed regularly.
Two successive interest rate cuts may not have got the party jumping just yet, but a new chapter begun.
