The Bank of Canada lowered its benchmark interest rate by a quarter-percentage point on Wednesday, marking a significant turning point in the central bank’s efforts to tame inflation.
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The Bank of Canada’s policy rate now stands at 4.75 per cent following six consecutive holds in previous meetings. The key rate informs the cost of borrowing widely in Canada, including what rates Canadians pay on their mortgages and other loans.
Homeowners with variable-rate mortgages, as well as Canadians with other kinds of debt tied to the central bank’s policy rate, will immediately see their interest rates drop by 25 basis points.
Bank of Canada governor Tiff Macklem said in prepared remarks Wednesday that the “considerable progress” made in taming inflation should be “welcome news” to Canadians.
“We’ve come a long way in the fight against inflation,” he said.
The Bank of Canada’s governing council is now confident enough in the cooling inflation trends that the central bank’s policy rate no longer needs to be as restrictive to restore price stability, Macklem said.
Canada has now become the first G7 nation to reduce interest rates amid a global effort to tame inflation. The Swiss National Bank was the first major economy to deliver rate relief in a surprise move in March, followed by the Swedish central bank in May.
Wednesday’s move was widely expected by economists and financial markets.
The rate cut came as annual inflation has cooled significantly from decades-highs in 2022, when the Bank of Canada’s tightening cycle began. The economy has also slowed and the labour market has loosened over the past two years, helping to relieve price pressures under the weight of higher interest rates.
‘Step in the right direction’ for borrowers
Homeowners with variable-rate mortgages, as well as Canadians with other kinds of debt tied to the central bank’s policy rate, will immediately see their interest rates drop by 25 basis points.
Variable-rate mortgage holders were hit the hardest during the Bank of Canada’s rapid tightening cycle, with their monthly payments ballooning in step with the central bank’s rate hikes.
James Laird, co-CEO of Ratehub.ca, says this is a defining moment for homeowners who held onto a variable rate despite the rising costs.
“For those who stuck with it, they were waiting for this day,” he tells Global News.
Ratehub calculated the impact Wednesday’s cut would have on a representative five-year variable mortgage rate of 5.95 per cent taken out on a home worth roughly $700,000. That homeowner, with a mortgage of around $650,000 outstanding, would have been paying $4,157 a month on their mortgage heading into the latest rate decision.
After the cut, the homeowner would see their rate drop to 5.7 per cent and their monthly payments reduced to $4,061. That results in nearly $100 less per month, or $1,152 per year, in mortgage payments.
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Laird says that variable-rate holders with a larger outstanding mortgage balance will see more of an impact from the rate cut, while those with a smaller balance won’t notice the savings as much. But regardless of a homeowner’s position, a drop in rates is good news for their finances, he argues.
“All mortgage balances are significant. So a quarter point is going to matter in people’s pocketbooks,” Laird says.
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Some variable-rate mortgage holders have fixed payments, with changes to their rate affecting how much of that monthly cost goes towards the interest or principal of a home.
Brampton, Ont., homeowner Zohaib Anjum Shaikh has fixed payments on his variable mortgage. He tells Global News that while the financial change won’t be significant, it’s nonetheless a good day for borrowers like himself.
“It’s a positive sign, but it is not a game changer. I just believe it’s a step in the right direction,” he says.
Laird says that Canadians trying to get into the housing market for the first time or homeowners up for renewal will have a difficult choice to make in the months ahead as they weigh variable or fixed-rate mortgages.
Variable-rate mortgages on offer in the market today are typically higher than fixed-rate options. Laird says that a homeowner choosing a variable mortgage today needs to be confident that rates will continue to decline by roughly two percentage points over the next two years to make the trade-off of forgoing a fixed rate worth it.
Where does the Bank of Canada go next?
The Bank of Canada said in a statement accompanying the decision that the latest economic data gave monetary policymakers more confidence that inflation would continue to decline back to the central bank’s two per cent target, though it cautioned “risks to the inflation outlook remain.”
Macklem said that if home prices rise faster than the central bank expects, or if global conflicts escalate, that could affect the inflation trajectory in Canada. Monetary policymakers are also still keeping an eye on wage growth, inflation expectations and corporate pricing behaviour as they forecasts where inflation goes next.
Macklem said that if inflation continues to ease, “it is reasonable to expect further cuts to our policy interest rate.” But he added that the central bank would take its decisions “one meeting at a time.”
As the Bank of Canada expects inflation’s journey back to two per cent will be “gradual,” Macklem said the pace of rate cuts will likely be the same.
In other words, Canadians should not expect the path interest rates took on the way up – the most rapid tightening cycle in the Bank of Canada’s history – to be the same pace at which the central bank lowers rates.
The Bank of Canada’s next interest rate decision comes on July 24, at which point it will also release new outlooks for inflation and the wider economy through its Monetary Policy Report. The central bank will get a look at two inflation reports and two labour market surveys before it has to make another decision next month.
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Financial markets priced in a 39 per cent chance of another rate cut in July following Wednesday’s decision, according to Reuters.
Economists weighing in after the Bank of Canada’s first cut of the cycle were divided on what rhythm the easing cycle would take. BMO and TD Bank economists see the central bank returning to pauses and cuts on an alternating basis, skipping a reduction at the next meeting and resuming in September; the likes of RBC and CIBC see the Bank of Canada going back-to-back with another 25-basis-point cut in July.
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“The first cut may not necessarily be the deepest, but it is the most significant, as it marks the official turning point after more than two years of restrictive policy,” wrote BMO chief economist Doug Porter in a note to clients Wednesday. “This is indeed likely to be the first of a series of cuts, although that series is not going to be a straight line down by any means.”
TD Bank director of economics James Orlando said in a note Wednesday that if the Bank of Canada diverges further from the U.S. Federal Reserve, which has struck a more cautious tone toward cutting rates amid a stronger U.S. economy, that would “put greater pressure on the loonie over the coming months.”
But Macklem pushed back against concerns about the impact of rate cuts on the Canadian dollar’s exchange rate with the greenback, arguing the economic conditions are different on either side of the border and the Bank of Canada did not need to move “lock and step” with its American counterpart.
“There are limits to how far we can diverge from the United States, but we’re not close to those limits,” he said.
Macklem was asked by reporters on Wednesday whether he was prepared to lower interest rates further at the next meeting, but he reiterated that the timing of future cuts is dependent on the data. The central banker also pushed back on reporters efforts to extract a clearer forward guidance from him.
“Let’s just enjoy the moment for a little bit,” he said with a grin.
“If you want to know where we’re headed, we’re headed to two per cent inflation and the interest rates are going to be what they need to be to get us there and keep us there.”
– with files from Global News’ Jillian Piper, Reuters
