The Bank of Canada cuts interest rates again

Wesley Blight

July 24, 2024

Key takeaways

The Bank of Canada cut the target for the overnight interest rate to 4.5% as inflation continues to ease.
Additional cuts are likely, but U.S. monetary policy will influence pace.
Cuts can provide a boost to Canadian equities and bonds with higher interest rate sensitivity, but may put additional pressure on the Canadian dollar.

For its second consecutive monetary policy meeting, the Bank of Canada (BoC) decided to cut interest rates by 0.25%, bringing its target for the overnight rate to 4.5%. The BoC also confirmed that it would continue to normalize its balance sheet by not replacing maturing Government of Canada bonds that it holds.

BoC: Broad inflationary pressures are easing and inflation is expected to move closer to target

After a small blip in May, Consumer Price Index (CPI) inflation moderated to 2.7% and is expected to settle near the 2% target next year. Core inflation, which continues to be below 3%, is expected to slow to 2.5% by the end of 2024 and ease gradually further through 2025. “With broad price pressures continuing to ease and inflation expected to move closer to 2%, Governing Council decided to reduce the policy interest rate by a further 25 basis points,” said the Bank.

We still expect the path of inflation moderation to be uneven. In Canada, excess supply (potential output is growing faster than actual growth) is an easing factor, while elevated prices in parts of the economy, namely housing and services, continue to be inflationary factors.

Economic growth expectations remain largely in-line with previous projections

Overall, global financial conditions have eased – generally, bond yields are lower and equity prices are higher. Growth in the U.S. is starting to slow, the Eurozone is starting to pick up steam and China is growing modestly. According to the BoC, global growth is expected to be 2.9% in 2024, 3.0% in 2025 and 2026. Our expectations are broadly in-line.

For Canada, the Bank expects growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. The BoC expects the economy to gradually absorb excess supply through 2025 and 2026 on strengthening exports, recovering household spending and business investment, robust residential investment and slowing population growth.

Additional easing is likely, but U.S. monetary policy will be a limiting factor

As I mentioned last month, we expect a Canadian target rate of 4.25% at the end of the year. This view is supported by weakened economic growth, inflation falling in line with the Bank’s own projections, and a labour market where job gains aren’t keeping pace with labour force growth. For 2025, further cuts are likely as the monetary policy rate is repositioned towards neutral (estimated by the BoC to be in the range of 2.25-to-3.25%).

However, the pace of future cuts will be increasingly influenced by the U.S. Federal Reserve (Fed) in fear that the Canadian dollar will come under additional pressure as the interest rate differential widens. While we expect the Fed to cut soon, it does not face the same urgency given the strength and resiliency of the U.S. economy. Generally, the Canadian dollar has trailed other major currencies, but has been relatively stable to this point.

Opportunities in the current environment

We’ve maintained our overall neutral view on equities, with a preference for North American equities. Canada’s ranking in our analysis is improving due to better macro conditions and the boost the rate cuts will provide. The U.S. remains remarkably resilient and relatively sheltered from Chinese and European weakness. It also continues to ride the artificial intelligence, cloud computing and energy transformation wave.

From a fixed income perspective, there is an opportunity to add value by increasing duration exposure (more interest rate sensitivity) on the front-end of the Canadian bond yield curve. At this time, we remain of convinced that short-term yields will continue to fall in absolute terms and relative to long-term yields.

You can read more about our short- and long-term outlooks and how we position portfolios here.

The BoC’s next interest rate announcement is scheduled for September 4^th and the Fed is scheduled to provide its latest decision on July 31^st.

Wesley Blight

Wesley Blight, CFA, CIM, FCSI, is a Portfolio Manager with the Multi-Asset Management Team of Scotia Global Asset Management. He is responsible for private asset and multi-asset portfolio solutions.

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