After dealing with decades-high inflation, Canadian consumers are beginning to see the effects of the Bank of Canada’s aggressive interest rate hike policy. Statistics Canada announced that the annual inflation rate cooled to 2.7% in April, down from 2.9% in March.
The lower inflation rate comes on the heels of slower growth in food prices, which increased 1.4% in April, down from 1.9% in March. These numbers are in stark contrast to the almost two-thirds of Canadians who believe inflation at grocery stores is getting worse. There is a caveat to those numbers; over the past three years, grocery prices have jumped 21.4%.
Inflation was moderated by rising gasoline prices though, which grew 6.1% in April from 4.5% in March. If you strip out gas, inflation slowed to just 2.5% in April.
What Caused Canada’s Inflation to Rise, Then Cool?
Inflation is now at its lowest level in three years and, for the last four straight months, has fallen within the Bank of Canada’s target range of 1% to 3%. With almost everything trending in the right direction, the big question now is when will the Bank of Canada announce its first-rate hike.
Lowering its key lending rate would be a big move for the Canadian economy. During the COVID-19 pandemic, the Bank of Canada lowered interest rates to 0.25% and held it there for two years. It did this to make borrowing cheap and help the economy avoid a recession.
Temporary inflation ended up being stickier than first thought and forced the Bank of Canada to announce a number of interest rate hikes. Since the start of 2022, the central bank has raised interest rates nine times, from a low of 0.25% in March 2022 to 5% in July 2023. It has held it there since then.
High interest rates make it more expensive to borrow and cut into household spending, which helps curb inflation. Though it’s been a bumpy ride. These moves helped lower inflation from a high of 8.1% in June 2022 to the current rate of 2.7%.
Will the Bank of Canada Announce Its First Rate Cut in June or July?
April’s inflation data is the last set of information the Bank of Canada gets before it announces its next interest rate decision on June 5. The fourth consecutive reading of tame inflation suggests the Bank of Canada will start lowering interest rates in early June.
Before the April announcement, the odds of a June rate cut were approximately 40%. Immediately after April’s inflationary data was released, the odds jumped to 53%. Benjamin Tal, deputy chief economist at CIBC believes the Bank of Canada will announce a 25 basis point (0.25%) cut in June, bringing interest rates down to 4.75%.
If there is a June rate cut, Tal thinks another rate cut will come in June and maybe September. A flurry of cuts doesn’t mean interest rates will fall to where they were during the pandemic or even the 1.75% rate in late 2019. Tal thinks interest rates will bottom in 2025 in a range of 3.0% to 3.75%.
Despite sustained lower inflation, a June interest rate cut is not a sure thing. A raft of economic data coming in over the next several weeks, including gross domestic product (GDP), jobs data, and additional inflation data could give the central bank even further evidence that the inflation trend is going in the right direction.
As a result, the odds of a rate cut coming on July 24, 2024 are locked in at 100%.
Who Will Cut First: The Bank of Canada or the U.S. Fed?
Despite the Bank of Canada being more dovish than other central banks, it needs to be somewhat cognisant of what is going on in the U.S. The U.S. Federal Reserve has held its interest rates at 5.25% to 5.5% since last July; the highest level since 2001.
It’s held its key lending rate at that level because inflation is still too high. Moreover, Fed Chair Jerome Powell has said that because of strong economic data, it will take longer than expected for inflation to fall toward the central bank’s 2% target. This has put once expected summer 2024 interest rate cuts into question. If anything, it now looks like interest rate cuts in the U.S. could begin in September. Later than expected, but not derailed.
Why does this matter? Tiff Macklem, the Governor of the Bank of Canada, has admitted that there is a limit to how far Canadian and U.S. interest rates can diverge. The U.S. Fed is expected to start cutting its interest rates later this year.
How much of a divergence can there be? Most believe it’s between 50 to 75 basis points, or 0.50% to 0.75%. If the difference is greater than this, it could put downward pressure on the Canadian dollar, which increases the price of imported goods and services. And rising costs are the last thing Bay Street and cash-strapped Canadians need to deal with.
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