On Wednesday October 23th at its regular policy meeting, the Bank of Canada (BoC) reduced the policy rate by 0.50 per cent, bringing it down to 3.75 per cent. This is the fourth rate drop in a row from the BoC (all happening since June), and as usual the rate reduction will quickly be passed through by banks and mortgage lenders to 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 5.95 per cent (6.10 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.

First, the national Gross Domestic Product (GDP) growth over this year is shaping up to be lower than expected, and is currently forecast to be just 1.2 per cent for 2024, growing to 2.1 per cent in 2025 and 2.3 per cent in 2026.

Second, the unemployment rate increased in September to 6.5 per cent. This is a small increase from August, and was driven largely by an increase in our population of working age people (through immigration) seeking employment. The increase reflects the fact that Canadian businesses are still seeing an excess of supply in the economy and are therefore not hiring to increase their production.

Finally, the Consumer Price Index (CPI) inflation measurement showed a significant drop in September to 1.6 per cent (down from 2.0 per cent in August). The BoC considers a 2 per cent inflation rate to be healthy for the economy and makes adjustments to monetary policy with the goal of keeping inflation around that level. September’s inflation data shows that the prices of most goods and services are now stabilized due to excess supply and reduced demand, and with a recent drop in global oil prices, gasoline prices at the pump are actually lower now than a year ago. Only shelter costs inflation (rent and mortgage payments) remains elevated well above 2 per cent, but the BoC expects these to ease directly as a result of lowering mortgage rates driven by their policy rate cuts.

What’s next for the policy rate?

All together, the above factors indicate that the Canadian economy is in a relatively weak position with more supply than demand.

GDP is a measure of how much is being produced by all Canadian businesses (in both goods and services), and meager GDP growth of 1.2 per cent for 2024 is a sign that businesses are struggling. Considering the fact that our population has been growing at a rate of about 1.2 per cent through 2023 and 2024, an expected GDP growth rate of 1.2 per cent this year means our GDP per person is actually 0 per cent.

Until now, businesses have largely avoided making large job cuts, but they have substantially reduced their hiring of new employees. Less hiring combined with our growing population is reflected in the higher unemployment rate, and over the next year or two this will result in relatively flat wage growth until this excess labour supply is absorbed. Since wage growth is viewed as a contributing factor to price inflation, expecting flat wage growth and seeing indications of excess supply means the BoC no longer has to worry about inflation.

Instead, the BoC now needs to worry about the economy becoming locked in an economic slump where businesses are stuck waiting for demand to increase before they increase their hiring, while many consumers are stuck waiting until they can get secure employment before they can begin buying more goods and services. In other words, the BoC needs to shift its monetary policy to become more stimulating for the economy.

Through reducing the policy rate, the BoC accomplishes three things to help break the above stalemate. First, all homeowners with variable rate mortgages or lines of credit immediately see their monthly payments go down, which frees up some money in the monthly budget for increased spending on discretionary items (increasing demand for businesses). Second, homeowners with fixed rate mortgages see that mortgage rates are coming down and can be more confident that their mortgage payments when they renew in the next year or so won’t jump catastrophically and they can also loosen up their budgets and spend a bit more money on discretionary items. Third, reduced borrowing costs allow businesses to more easily borrow money to fund new projects and hire new teams in anticipation of demand picking up. 

At the next BoC meeting on December 11th, we expect another rate cut of between 0.25 and 0.5 per cent. Then over 2025, we expect to see regular rate cuts adding up to at least another 1 per cent in total rate decrease over the calendar year.

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