Bank of Canada Likely to Cut Rates by 25 Bps on Wednesday: What to Expect

The Bank of Canada is widely expected to cut interest rates by 25 basis points (bps) on Wednesday, as it seeks to support economic growth and maintain its 2% inflation target. This move comes amidst a slowing economy, easing inflation, and persistent slack in the labor market. Let's delve into the key indicators, the Bank's projected path for inflation and economic growth, and the potential impacts of a 25 bps rate cut on consumer spending, business investment, and the housing market.



Key Economic Indicators and Their Evolution

1. Gross Domestic Product (GDP) Growth: The Canadian economy grew by 2.1% in the second quarter, led by government spending and business investment. However, preliminary indicators suggest that economic activity was soft through June and July. The Bank will consider this slowdown in economic growth when making its decision.
2. Inflation: Inflation slowed further to 2.5% in July, as expected. The Bank's preferred measures of core inflation averaged around 2.5%, and the share of components of the consumer price index growing above 3% is roughly at its historical norm. High shelter price inflation is still the biggest contributor to total inflation but is starting to slow. The Bank will assess these opposing forces on inflation when deciding on the rate cut.
3. Labour Market: The labour market continues to slow, with little change in employment in recent months. Wage growth, however, remains elevated relative to productivity. The Bank will consider the labour market conditions when making its decision.
4. Global Economic Conditions: The global economy is evolving largely as expected, with the US economy showing broad-based strength and the Canadian dollar depreciating in the face of broad-based strength in the US dollar. The Bank will consider global economic conditions when deciding on the rate cut.

The Bank of Canada's Projected Path for Inflation and Economic Growth

In the October 2024 Monetary Policy Report, the Bank projected that inflation would remain near the 2% target, while economic growth was expected to pick up gradually. However, there are risks to these projections that could influence the Bank's decision to cut interest rates. These risks include the evolution of shelter prices, the impact of higher energy prices on core inflation, and the potential impact of US tariffs on Canadian exports and the global economic outlook.

Potential Impacts of a 25 Bps Rate Cut

1. Consumer Spending: Lower interest rates reduce debt-servicing costs for some households, making them more likely to spend. However, households renewing five-year fixed-rate mortgages will face increased debt-servicing costs, which may dampen their consumption spending. The Bank of Canada expects consumption per person to rise, supported by lower interest rates and higher household wealth.
2. Business Investment: Lower interest rates make borrowing cheaper for businesses, encouraging them to invest in new projects and expand their operations. The Bank of Canada expects business investment to strengthen over the projection, underpinned by lower interest rates and higher demand.
3. Housing Market: Lower interest rates make mortgages more affordable, encouraging homebuyers to enter the market and existing homeowners to renovate or upgrade their homes. The Bank of Canada expects residential investment to pick up, with growth in resales and renovations supported by lower interest rates.

In conclusion, a 25 bps rate cut by the Bank of Canada could stimulate consumer spending, business investment, and the housing market. However, the overall impact depends on the economic context and the specific circumstances of households and businesses. The Bank will carefully assess the key economic indicators and the risks to its projections when making its decision on Wednesday.