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Bank of Canada Cuts Rates Amid Cooling Economy

Canadian Economics

By: Walter Bolduc

    

The Bank of Canada reduced the target for the overnight rate to 2.5 per cent, with the Bank Rate at 2.75 per cent and the deposit rate at 2.45 per cent.

  • A weaker economy and less inflationary concerns compared to earlier this year made a cut appropriate.
  • In the United States, business investment has been healthy but signs of a slowing economy are emerging, with inflation picking up as some tariff costs pass through.
  • Elsewhere around the globe, Euro-area growth has moderated with higher U.S. tariffs impacting activity. Meanwhile, China is softening as investment weakens.
  • Canada’s economy contracted by an annualized 1.6 per cent in the second quarter as tariffs and trade uncertainty weighed on activity. Exports contracted sharply in the spring after firms pulled orders forward in the first quarter. Meanwhile, business investment also declined.
  • Households have been resilient so far during the trade war, as consumption and housing activity grew at a healthy pace in the second quarter. However, slowing population growth and a weaker labour market are likely to weigh on household spending in the coming months.
  • Employment has fallen over the past two months since the Bank’s July Monetary Policy Report. Losses have been concentrated in trade-sensitive sectors, though hiring has broadly cooled across the Canadian economy. Wage growth has continued to ease as a result.
  • CPI inflation was 1.9 per cent (year-over-year) in August, driven down by the removal of the consumer carbon tax in April. Excluding taxes, inflation was 2.4 per cent.
  • Preferred core measures of inflation have been around 3 per cent in recent months, but the Bank notes that broader indicators suggest underlying inflation is near 2.5 per cent, and that the federal removal of most retaliatory tariffs on U.S. goods should reduce future price pressure on those items.
  • The Governing Council will monitor how exports fare under U.S. tariffs and shifting trade relationships, the spillovers to investment, employment, and household spending, the pass-through of cost changes from supply-chain reconfiguration to consumer prices, and the evolution of inflation expectations—aiming to support growth while keeping inflation well controlled.

Insights

Less retaliation, less inflation. Up to now, inflationary concerns about the trade dispute with the U.S. have largely been evaded, with only a modest impact from Canada’s retaliatory tariffs on headline CPI seen over the past few months. Looking ahead, we’re cautiously optimistic that this trend will continue, and that inflation will continue to moderate. On September 1, the federal government removed retaliatory tariffs on $44 billion worth of goods which have been in place since March. The removal of these tariffs will take away some upward price pressure and has instilled further confidence in the Bank’s decision to cut its key policy rate today.

Employment warning signs in August. Trade uncertainty is setting into labour markets as firms reevaluate hiring and investment decisions. Over the past two months, Canada’s employment fell by over 100,000 jobs, with the losses concentrated in industries with significant exposure to trade such as manufacturing and warehousing. With upward price momentum easing compared to earlier this year, and the Canadian economy teetering on a recession, the Bank is diverting its attention toward stimulating economic growth.

U.S. interest rate cuts will help Canada’s inflation outlook. We expect the United States will have two interest rate cuts between September and December of this year. Barring any shocks to the Canadian economy, we think the Bank of Canada will have reached the floor of its rate cutting cycle after today’s announcement. The additional rate cuts in the U.S. will narrow the interest rate differential with Canada and improve the Loonie’s U.S. dollar exchange rate. The stronger Canadian dollar will be an added force helping moderate Canada’s inflation by making American imported goods more affordable.

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