On Wednesday July 24th at their regular policy meeting, the Bank of Canada (BoC) announced another 0.25 per cent cut to the policy rate, bringing it down to 4.5 per cent. Banks and lenders will quickly pass this rate reduction through to their customers with variable rate mortgages and lines of credit.

This is the second rate drop in a row by the BoC as they slowly unwind the restrictive monetary policy of the last 14 months.

Variable rate mortgage holders whose mortgage payments change with prime (some lenders call these adjustable rate mortgages) and who have a 25 year amortization can expect to see their monthly payments go down by just under $15 per one hundred thousand dollars of mortgage debt.

Why did the Bank of Canada cut the policy rate?

With a slew of negative economic data coming out about the Canadian economy in the last few weeks, it is becoming more apparent that our economy is cooling and the risk of inflation is waning.

Most recently, Statistics Canada reported that retail sales fell from April to May by 0.8 per cent, showing a broad based softening of consumer spending but led most prominently by a drop in food and beverage sales. Statistics Canada also predicts that the soft sales will persist through June with another reduction of 0.3 per cent from May.

When sales are softening like this, despite our growing population and the fact that prices are not deflating, it’s a strong signal that our economy is heading towards recession in the near future if something doesn’t shift to help consumers out.

The weak sales numbers that came out last week came on the heels of an employment report a few days earlier that showed our economy shed 1,400 jobs in June when economists predicted the economy would add 25,000 new jobs. Shedding jobs means companies are cutting back on plans for expansion due to predicted slower sales (either through laying off employees or deciding to remove vacant job offers and leave those positions unfilled). Again, combined with our growing population, this is bad news and our unemployment rate rose to 6.4 per cent as a result – with an increase of 42,000 unemployed individuals from May to June for a total of 1.4 million unemployed.

Last but not least, we received the June inflation report which showed that inflation dropped to 2.7 per cent. This was good news for the BoC after the surprise increase in May’s inflation rate to 2.9 per cent (from 2.7 per cent in April). Inflation coming back down shows that our economy is still trending towards a more balanced position with supply able to meet demand.

Outside of Canada, the BoC is also seeing trends that support lower rates. In the United States, inflation is trending down and consumer spending (consumption growth) is moderating, both of which are making it more likely that the U.S. Federal Reserve will be able to start cutting rates at the end of this year (likely after the election, as they tend to not make any changes that could be seen as influencing voters).

What’s next for the policy rate?

Looking forward, the BoC is projecting that Gross Domestic Product (GDP) growth will be 1.2 per cent in 2024 followed by 2.1 per cent in 2025. This is quite an upward trend from the last 2 quarters of official data, where we saw GDP growth of only 0.4 per cent in the first quarter of 2024 and 0 per cent in the last quarter of 2023. In its statement, the BoC says this growth in GDP is expected to come from “stronger exports and a recovery in household spending and business investment as borrowing costs ease.”

For “borrowing costs easing” to result in such a significant shift in GDP growth, they will have to be pretty substantial cuts in total. Right now, economists from the major financial institutions are indicating that we’re likely to see a few more quarter point policy rate cuts this year and around another 1 per cent in cuts over 2025 (for a combined 2 per cent drop in the policy rate from the high of 5 per cent in May 2023 down to about 3 per cent by the end of 2025).

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