The Bank of Canada’s interest rate decisions shape Canada’s economy. They are aimed at balancing inflation control with economic growth. As the October 23, 2024 announcement nears, speculation is mounting: will rates rise, fall, or remain steady?
From March 2022, the Bank of Canada began raising the overnight rate to combat inflation, increasing it from 0.25% to a peak of 5.00% in July 2023. The rate remained unchanged until June 2024. Since then, the Bank has announced three consecutive cuts, bringing the current rate to 4.25%.
In this blog, explore the key factors influencing the next decision.
Key Factors
Inflation: The Primary Target for Rate Decisions
Inflation directly impacts purchasing power and price stability, which is why it’s the primary factor in the Bank of Canada’s rate decisions. High inflation erodes the value of money, prompting central banks to raise rates to curb spending and cool the economy. However, as inflation lowers, rate cuts may be necessary to encourage economic activity.
Latest Data: As of September 2024, inflation has cooled to 1.6%, a significant drop from August’s 2.0%. A large drop in gasoline prices was the primary contributor in this decrease, but high shelter costs continue to account for the majority of inflationary pressures. Core inflation, which excludes volatile components like food and energy, stands at 2.4%, just above the Bank’s 2% target.
Economic Growth (GDP)
Gross Domestic Product (GDP) measures the overall economic activity and health of a country. Sluggish GDP growth can signal a weak economy, leading to potential rate cuts to stimulate demand. Conversely, strong GDP growth can prompt rate hikes to prevent overheating.
Latest Data: On an annualized basis, GDP grew 2.1% in Q2 2024, exceeding forecasts and marking the strongest growth since Q1 2023. Month-over-month GDP rose by 0.2% in July 2024, but a preliminary estimate for August shows flat growth, suggesting third-quarter performance may fall short of the Bank of Canada’s 2.8% annualized forecast.
Labour Market Performance
The labour market serves as a barometer for economic strength. Strong job growth and wage increases can drive inflation higher, leading to rate hikes. On the other hand, rising unemployment typically signals a cooling economy, which may prompt rate cuts.
Latest Data: Canada’s unemployment rate eased to 6.5% in September 2024, down from 6.6% in August, and beating expectations of 6.7%. This marks the first decline since January, alleviating concerns about a softening labour market. However, the unemployment rate remains about a percentage point higher than a year ago, and job openings continue to fall rapidly into September, indicating potential challenges ahead for the labour market.
Consumer Spending and Household Debt
Consumer spending drives a significant portion of the economy, but rising debt levels can become problematic, especially during periods of high-interest rates. The Bank of Canada must carefully balance encouraging consumer spending while ensuring household debt doesn’t spiral out of control.
Latest Data: Retail sales rose by 0.9% in July 2024, recovering from a two-month slump. However, per capita retail spending continues to decline, signaling potential challenges for the economy. Consumer debt is at an all-time high, primarily due to high-interest mortgages and credit cards. While expectations of future sales has slightly improved, businesses continue to see weak demand as consumers exercise caution.
Housing Market Conditions
The housing market is highly sensitive to interest rate changes. Higher rates typically lead to slower home sales, reduced mortgage activity, and increased delinquencies as borrowing costs rise. The Bank monitors this closely since the housing sector significantly impacts overall economic activity.
Latest Data: Rising borrowing costs are further dampening housing market activity. Housing starts rose 5% in September 2024, but remain significantly below levels needed to restore housing affordability. Despite a 1.9% increase in September, home sales remain below the 10-year average. Buyers are delaying purchases due to anticipated rate cuts from the Bank of Canada. Mortgage delinquencies are increasing, especially in major urban centers.
Global Economic Factors
Canada’s economy is intertwined with global markets, especially the U.S. As a result, decisions made by the U.S. Federal Reserve, global inflation trends, and international trade dynamics all play a role in shaping the Bank of Canada’s interest rate decisions.
Latest Data: In September 2024, the U.S. Federal Reserve cut rates by 0.50%, reflecting its confidence in managing inflation while supporting economic growth. This could influence Canada’s own policy decisions due to the close economic ties between the two nations.
Financial Market Performance
Financial markets, including stocks and bonds, can influence central bank decisions. A rising 10-year Treasury yield may signal the need to raise short-term interest rates to prevent overheating, while falling yields could lead to rate cuts to support economic growth.
Latest Data: The Canadian stock market remains relatively stable. Canada’s 10-year government bond yield has been on a downtrend since July 2024 as inflation continued to cool. However, it has been on a slight uptrend since September 2024. This may signal that the market has some doubt about how aggressively the Bank of Canada will cut rates.
Geopolitical Risks
Geopolitical events, such as trade disruptions or conflicts, can impact economic stability by driving up costs for energy or other goods. The Bank of Canada monitors these risks as they can exacerbate inflationary pressures or dampen global trade.
Latest Data: Ongoing geopolitical tensions and potential global trade disruptions could affect Canada’s energy markets and overall economic health. Oil prices rose nearly 2% on October 21, recovering some losses from the previous week’s 7% drop. The increase was driven by concerns over potential supply disruptions due to ongoing conflict in the Middle East and expected Israeli retaliation against Iran.
The Likely Outcome for October 23, 2024
With inflation now below the 2% target at 1.6% and economic growth slowing, most analysts predict the Bank of Canada will follow the U.S. Federal Reserve and cut the key interest rate by 0.50%. The weakening Canadian dollar reflects market anticipation of this “jumbo cut”. Some analysts even suggest a larger 0.75% cut is possible.
If the Bank adopts a more cautious, dovish stance, we could see a 0.25% cut at both this meeting and the next on December 11, 2024. A rate cut is almost guaranteed, with the main uncertainty being its size.
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