Canada’s inflation rate unexpectedly slipped below 3% in January, into the Bank of Canada’s target range of 2% to 3%. There’s still work to do if the central bank wants to get inflation down to 2%, but to do so, it may need to keep interest rates higher for longer.
That would be bad news for Canada’s frail economy, which has been straddling a recession since the start of 2023.
How Is the Canadian Economy Doing?
In the fourth quarter of 2023, Canada’s gross domestic product (GDP) inched up 1%, this is after a 0.5% decrease in the third quarter and a 0.2% fall in the second quarter.
Canada’s weak economy comes courtesy of higher interest rates from the Bank of Canada, which has held its key lending rate at 5%, the highest level since 2001. Higher interest rates have curbed Canadian spending.
Should the Bank of Canada choose to leave interest rates higher for longer just to get inflation down to 2%, it could lead to weak earnings on Bay Street, higher bankruptcies, and weak consumer and business confidence.
The combination of high inflation, decades-high interest rates, and soaring household debt, has seen Canadian consumers pull back on spending. Total household spending has stalled since the second quarter of 2023.
On Bay Street, flat sales and higher interest rates have driven down profits. In the third quarter of 2023, corporate profits were just $167 billion, roughly half the 2022 average of $324 billion.
A big part of the reduced spending is a result of mortgage renewals at higher rates. In the U.S., most Americans have a 30-year mortgage, so higher interest rates won’t have an immediate impact on their finances like they do in Canada. Here, the average mortgage comes with a five-year term.
As a result, Canadians are bracing for higher costs come renewal time and are spending less to save more. In the U.S., households are spending more and saving less. That’s a big reason why the U.S. economy is doing exceptionally well whereas the Canadian economy has been straddling a recession.
Will the First Interest Rate Cut Come in April?
To avoid a deep, prolonged recession, the Bank of Canada may have to cut interest rates sooner rather than later. While some analysts believe the central bank will announce its first interest rate cut in June, a growing number see the first cut of a quarter-point, to 4.75% coming April.
By December it’s expected the Bank of Canada will have announced four 25-basis point cuts, bringing interest rates down to 4%. By the end of the year, 40% of analysts think inflation will be in the 2% to 3% range, while more than 26% believe it will be in the 1% to 2% range.
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Inflation has fallen into the Bank of Canada’s target range but interest rates remain elevated. With economic growth stagnating and corporate profits down, an April rate cut is not out of the question. If you want to know how lower interest rates and a fragile economy impact stocks, ask the trading experts at Learn-To-Trade.com.
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