On Wednesday December 11th at its regular policy meeting, the Bank of Canada (BoC) reduced the policy rate by 0.50 per cent, bringing it down to 3.25 per cent. This is the fifth rate drop in a row from the BoC (all happening since June), and this rate reduction will cause banks and mortgage lenders to cut their consumer prime rates for customers with variable rate mortgages and lines of credit. With most banks and mortgage lenders, this will mean a drop in their prime rate to 5.45 per cent (5.6 per cent for TD).

For variable rate mortgage holders whose mortgage payments change with prime (some lenders call these adjustable rate mortgages) this will mean a decrease in mortgage interest costs of about $40 per one hundred thousand of mortgage debt (assuming a 25 year amortization).

Why did the Bank of Canada cut the policy rate?

There are three key factors the BoC referred to as influencing its decision to cut the policy rate today, and they are the same 3 factors that caused the bank to make it’s previous 0.5% rate cut in October.

First, the national Gross Domestic Product (GDP) growth over this year continues to disappoint. The most recent data for Q3 came in below the BoC’s 1.5 per cent projection (at 1 per cent), and their projection for Q4 has also been dropped meaning the current quarter is looking weak as well.

Next, the unemployment rate increased in November to 6.8 per cent, as businesses are not creating as many new jobs as there are people seeking employment. This is the highest unemployment rate we’ve seen since 2017 (excluding the brief fluctuations due to lockdowns during the pandemic), and is a strong sign that businesses are not expecting or preparing for increased production in early 2025 (a strong sign that 2025 Q1 GDP will also come in weak).

Last but not least, the Consumer Price Index (CPI) inflation measurement continues to hover around 2 per cent (which is the BoC’s target) and has been for the last few months. Since higher interest rates are primarily used to bring down inflation when it’s too high, the BoC now considers its monetary policy overly restrictive and will continue to slowly ease as long as inflation doesn’t show signs of trending upwards again.

What’s next for the policy rate?

All together, the above factors continue to indicate that the Canadian economy is in a relatively weak position with more supply than demand. The BoC has forecast that it expects to continue with rate cuts into 2025, but likely at a slower pace than the previous 6 months.

Most economists expect to see another 3 to 4 rate drops over 2025 of 0.25 per cent each and ending with the BoC policy rate sitting at about 2.25 to 2.5 per cent (which would be considered a neutral monetary policy position).

However, as we discussed in our last post, the big unknown that could drastically swing the policy rate higher or lower is what the incoming U.S. president Donald Trump will actually do for trade policy when he takes office in January. If he introduces significant new tariffs on Canadian exports to the U.S., that could be a significant negative impact on our economy and require further rate cuts to prevent recession. But then if the Canadian federal government introduces retaliatory tariffs on imports of U.S. goods into Canada, that could cause drastic inflation and require the BoC to significantly increase the policy rate to fight against.

At the press conference today, BoC governor Tiff Macklem was asked by reporters about these scenarios and he acknowledged that the BoC governing council was considering both possibilities and preparing contingency plans, but that with so much still unknown about the tariffs “we can’t run policy on something that might happen.”

The next scheduled BoC rate announcement is January 29, 2025, at which time we may have a much better idea about Trump’s tariffs and how they are going to impact the BoC monetary policy for 2025.

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