Experts predict a larger-than-expected rate drop as Bank of Canada reaches inflation target
Canada’s inflation rate finally hit the central bank’s 2% target in August, raising expectations for a 50-basis-point interest rate cut next month.
The consumer price index (CPI) posted its slowest annual increase since February 2021, while core inflation measures also cooled to their lowest levels in more than three years, according to Statistics Canada.
The data showed that consumer prices fell by 0.2% month over month, with annual inflation easing from 2.5% in July to 2%. Economists had predicted a slightly higher figure of 2.1%.
This cooling of inflation, combined with declining economic growth, has analysts predicting that the Bank of Canada will move toward a rate cut in its upcoming policy decision.
"We expect central bankers to slash their policy rate by 50 basis points next month in an effort to expedite the return to a more neutral setting," said Royce Mendes, head of macro strategy at Desjardins Group.
The rate cut, according to Mendes, would help the country return to a more neutral interest rate range—between 2.25% and 3.25%—which neither stimulates nor stifles economic growth.
Economic slowdown
The Canadian economy has been slowing for months, with third-quarter growth expected to be roughly half of the BoC's forecast. At the same time, the unemployment rate has crept higher, adding further pressure for policy easing.
"The gradual rise in the unemployment rate and slowing pace of economic growth suggest high interest rates are working to cool the economy," Randall Bartlett, senior director of Canadian economics at Desjardins, wrote in a report. “In fact, maybe they're working too well.
"We think the BoC is likely to cut the policy rate by 50 basis points at its October announcement."
With inflation easing and economic growth stalling, money markets are now fully pricing in further rate cuts. The Bank of Canada has already reduced rates by 75 basis points in 2024, bringing the policy rate to 4.25%.
Many market watchers expect two additional 25-basis-point cuts before the end of the year, with growing support for a larger 50-basis-point reduction at the October meeting.
Analysts predict a larger October move would be aimed at softening the impact of high borrowing costs on households, particularly as housing prices and rents remain elevated.
Contributing factors
Much of the reduction in inflation can be attributed to falling gas prices, which dropped 5.1% in August. Prices for clothing and footwear also declined, contributing to the easing of overall inflation.
However, shelter costs remain a major driver of inflation, with mortgage interest and rent prices continuing to rise, albeit at a slower pace. Mortgage interest costs rose by 18.8% in August, down from 21% in July, while rents increased by 8.9%, up from 8.5% the previous month.
Read more: Could the Bank of Canada focus on shelter inflation backfire?
StatCan said shelter costs, which make up a significant portion of the consumer price index, are still pressuring households, even as other areas of the economy show signs of relief.
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