On Wednesday June 5th at their regular policy meeting, the Bank of Canada (BoC) has decided to reduce their Policy Rate by 0.25 per cent, making the new policy rate 4.75 per cent. Consumer lenders should quickly pass this rate reduction through to their customers with variable rate mortgages and lines of credit which are based on lender prime rates.

This is the first rate drop by the BoC since March of 2020.

While a rate drop was largely expected at either today’s meeting or the next in July, it is still a very welcome relief to the thousands of households across the country with variable rate mortgages, who saw their payments increase so dramatically over 2023.

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?

The most recent economic data shows that inflation continues to come down in most advanced economies around the world. Most importantly for Canada, the United States is showing signs of slowing economic growth and a more balanced job market, which are both important for the U.S. Federal Reserve in its fight against inflation.

In Canada, GDP growth in the first quarter of 2024 came in lower than expected at 1.7 per cent. While this is an improvement over the second half of 2023 where we had no growth, it is still weak overall. In the job market, employment has been growing, but at a slower pace than working-age population growth, so the net effect is more people are looking for work which is putting downward pressure on wage growth.

Last but not least, the Consumer Price Index (CPI) inflation rate dropped in April to 2.7 per cent and other core inflation measures also showed continued downward momentum. CPI inflation was 2.8 per cent in February but increased to 2.9 per cent in March, so the decrease to 2.7 per cent in April helped ease fears and re-establish that we are seeing a general downward trend. What’s more, the CPI inflation in April continues to show substantial drops in the price inflation of groceries, services and durable goods, with only shelter costs (mortgage payments and rent) staying stubbornly high. And since shelter costs are high largely because of the BoC’s high policy rate (which causes mortgage rates to be higher), this segment of the CPI will only start to come down when the BoC reduces the policy rate.

What’s next for the policy rate?

Economists seem to agree that we will see between 1 to 3 more rate cuts this year of 0.25 per cent each. However, exactly when those happen will depend significantly on the reaction of Canadians to this initial rate decrease and also on its impact to the value of our currency against the US dollar. If the US Federal Reserve continues to keep rates high through the summer it would cause the value of the Canadian dollar to drop, making it more expensive for grocery companies and retailers to buy supplies and inventory from the U.S. to stock Canadian shelves. This in turn would cause consumer prices to go up, which is counterproductive to the BoC’s goal of bringing inflation down to 2 per cent.

Looking forward then, the speed at which the BoC can reduce its policy rate and provide Canadians with mortgage payment relief is going to depend significantly on when the Fed begins to cut and how aggressively it does so.

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