The Decibel - What the Bank of Canada’s interest rate cut means for you

Episode Date: June 6, 2024

The Bank of Canada lowered the interest rate to 4.75 per cent on Wednesday – the first rate cut in four years. As the country’s central bank aims to get the inflation rate closer to 2 per cent, further cuts could be on the horizon. Realtors are hoping the rate cut will reignite a stagnant housing market, by possibly allowing more people to qualify for mortgages and increasing the number of potential buyers.Mark Rendell is a journalist with The Globe’s Report on Business. He joins the show to discuss the art and science behind rate cuts, what the current cut means for people and the economy and how the Bank of Canada might move forward.Questions? Comments? Ideas? E-mail us at [e-mail]

For nearly a year, Canada's benchmark interest rate has been at its highest level in two decades. Back in February 2022, the interest rate was at 0.25%, and then the Bank of Canada hiked it quickly, bringing it to 5% in August 2023. And the rate has stayed there ever since. That is, until Wednesday. That's when the Bank of Canada finally lowered the interest rate. Mark Rendell is a journalist in the Globe's report on business and has been covering Canada's central bank during this time. He's on the show to explain this rate cut and how it will affect Canadians directly. I'm Maina Karaman-Wilms, and this is The Decibel from The Globe and Mail. reporter. Thanks so much for having me. It's, you know, a rate cut day is like Christmas for a BOC reporter. So it's an exciting day. And yeah, great to be here to chat with you about it.

Well, let's get into what actually happened then on Wednesday. So what did the Bank of Canada lower the interest rate to? And what did the governor, Tiff Macklem, actually say about why they did that? Yeah, so it was a big day. They cut the policy interest rate, which is the benchmark for the rest of the interest rate market from 5% down to 4.75%. And that may sound like a small amount, it's only a quarter of a percentage point, but it's the first time they've cut in four years. And in fact, the first time they've cut since interest rates started going up very rapidly in 2022. Now they pushed interest rates up very, very quickly because they were trying to get inflation back under control. The idea is you increase borrowing

costs that makes it more expensive to borrow money. So it's kind of acts as a gigantic break on inflation. And the idea is you're slowing the economy to slow down the pace of inflation, which in the summer of 2022, it got as high as 8%. Now, that's four times the Bank of Canada's target. And that kind of trade-off that's always there in monetary policy between essentially hurting the economy or constraining the economy for the sake of controlling inflation, that balance or that trade-off is tilting in favor of interest rates coming down. So you don't choke off the economy too much because we're at a point where essentially

they think they're on a glide path. They think they're going to get there with inflation. And so it's no longer justified to have interest rates as restrictive as possible. So a very small first step, only a quarter of a percentage point, but it starts a monetary policy easing cycle and sets up further interest rate cuts this year and going into next year. Why only a quarter point cut? Why not a half point? Why not even a full point? So central bankers, they're a pretty cautious lot and they tend to like to move in small increments if they can. Certainly, when they were pushing interest rates up, they were doing really

big steps in 50 basis point increments, 100 basis point increments. That would be like 50 is like a half point. Half point. Is a full point, yeah. Full percentage point, right? So they're going really, really fast to get interest rates up. Now they're coming back down. They're moving more slowly. They're moving more gradually. Going forward, you might not even see a rate cut at every single rate decision. They could potentially skip interest rate decisions. So there's lots of uncertainty about kind of what happens next. It's clear that rates are going to come down, but it's probably going to be a kind of slow

and gradual process. So if they're being so cautious here, I guess I have the question on the other side of things then. Why not play it more safe? Like, would there have been a risk in just keeping the rate at 5%? There is a risk. I mean, right now, interest rates at 5%, which is the highest in 20 years, that's a very restrictive level that chokes off economic activity.

So there is a risk that if you wait too long, you can push the economy into a recession. Let's talk about making this decision, Mark. I guess I want to get a sense of how difficult a decision this is for the central bank. It sounds like it's kind of a bit of a tricky dance. Has the bank struggled with making the right call in the past? It is a tough decision. It's a tough decision for a number of reasons, but not least because the banks made a couple of errors, a couple of pretty big errors in the last few years. When inflation took off in 2021, they kind of sat on their hands for months and didn't start raising interest rates. They thought that inflation would be transitory, that it would come back down, and they got burned by that. And by the time-

So they maybe didn't act as quickly as they maybe should have at that point? It's exactly it. Yeah, they should have started raising interest rates faster than they did. They've subsequently acknowledged that. And so that was a mistake. And that made them essentially have to play catch up through 2022 and 2023 to get inflation back under control. So having made that error a couple of years ago, it makes them nervous. They've essentially been scarred by the experience of high inflation. That's the central banker's ultimate nightmare. They basically have one job. Their one and only job is to keep inflation under control. And central banks, not just the Bank of Canada, but all around the world, they kind of botched that job coming out of the pandemic. And so there's been a lot of reticence at central banks

to essentially shift things into reverse and start easing monetary policy because we've had such a big inflation shock. They don't want to risk that coming back again. So let's actually look at some of the details behind this decision here, Mark, that led them to make this cut. What are some of the economic indicators that they were looking at? So the biggest thing was the inflation numbers, which have been pretty good. So inflation, which was running as high as 8% in mid-2022, has come down a lot. A lot of price pressures of easing, and that's both the prices of goods and the prices of services. All told, when you put it all together, headline consumer price index inflation,

which is the kind of target that they're aiming for, has been below 3% since January. And that's important because the Bank of Canada, while it targets 2% inflation, it has a control band of 1% to 3% kind of around the target. And so for the whole course of the year so far, inflation has been in that target range. It was 2.7% in April, which was the latest number we have. And a lot of the other kind of what they call core indicators of inflation, which is when you start dicing up the consumer price index basket, when you start stripping out volatile prices, like for food and energy. This is the CPI we often talk about,

yeah. Exactly, the consumer price index basket. And those core measures of inflation have all been trending lower. And in like a shorter three-month annualized rate are actually essentially back around 2% already. The biggest thing that led to the cut this week was the inflation numbers. They're also looking at a whole range of economic indicators because, again, they want to see the economy essentially flatlining in order to keep those inflation metrics on a downward path. you can look at GDP growth. So central bankers talk about essentially if the economy is operating above potential, if the economy is running faster than potential, there's going to be upward pressure on prices.

If it is running slower, there's going to be a downward pressure on prices. And for the past year, it's essentially been operating below its potential. So in tactile terms, GDP picked up a bit in the first quarter after essentially stalling last year, but it has been very, very low. The Bank of Canada also looks at labor market indicators. It's looking at the unemployment rate, it's looking at job vacancies, and it's looking at the speed with which wages are picking up. And you're seeing across a number of indicators, the labor market is cooling down a little bit. Yeah. So we talked a lot about the tangible, quantifiable numbers here, but then it sounds like there's also this other side of things

that's a little bit more intangible that actually affects their decision-making. What are they considering on that front? So a big part of monetary policy is trying to control people's expectations about the future and expectations about future price increases. And that's because expectations can kind of become a self-fulfilling prophecy. If I expect prices are going to keep going up, I'm going to go to my employer and I'm going to ask for higher wages. If companies are experiencing wage pressures, or if they think the costs are going to go up in other ways, they're more likely to raise prices. So part of what the Bank of Canada is trying to do when it communicates with the public is it's trying to essentially guide inflation expectations or anchor inflation expectations one way or another. So that's one of the reasons why you've heard Tiff Macklem talk very tough over the last two years, and a lot of that has to do with trying to anchor those inflation expectations. And you are seeing, especially on the business side, if you look at business surveys, it does seem like companies expect inflationary pressures to be lower going forward.

Consumers still think inflation is going to be pretty high. A lot of what informs individuals' expectations about inflation, a lot of how they form beliefs about inflation has to do with things like gasoline prices and food prices. At the end of the day, what is an economy? Economy is people spending money, people saving money, people deciding what to do. And when you're trying to control that behavior, which is essentially what monetary policy is trying to do. And when you're trying to control that behavior, which is essentially what monetary policy is trying to do, you can do it in a very tactile way. I can literally make it more expensive for you to borrow money to go buy a car. Or I can also convince you that, hey, maybe it's not a good

time to go buy a car, right? But ultimately, the end point, what they're trying to do is influence behavior. And just remind us, when the Bank of Canada makes a decision like this, is politics a factor here? So the Bank of Canada is independent from the rest of the government. Essentially, they are delegated the power to set interest rates and control the currency. But you can bet there's a lot of interested politicians. Mark, I think the question a lot of us have is how this is going to affect us. So how much is a quarter point cut, which is what the change is? How much effect is that going to have on people's day-to-day lives? Not that much in terms of dollars and cents. A quarter percentage point is not a huge amount on your mortgage. A colleague of mine, Erica Alini,

who covers personal finance, crunched some numbers ahead of the decision. She found, let's say you have a mortgage balance of about $330,000, which is roughly the Canadian average. You have a five-year adjustable rate mortgage, a quarter point cut is going to save you about $47 a month. Not a huge amount. If you're a new home buyer and you're looking to buy the average house and you're looking to take out a mortgage of around $700,000, if you did that before the rate cut and after the rate cut, it's about $100 a month difference. Another thing to keep in mind as well is lots of mortgage rates are fixed rate mortgages. So

you're locked into a five-year contract or a three-year contract. So when interest rates change, that's not going to change your interest rate until you actually renew that contract. It's less about one single cut and the impact that's going to have. And it's more about what this week's move suggests about where interest rates are going over the next couple of years. And so one rate cut might not be that much, but once you get three, four, five, six rate cuts, then you're talking about real dollars. We'll be right back after this message.

Okay, so Mark, we've looked at how this will affect individual Canadians, but let's look more broadly now at the housing market. What might be the effect on the housing market in Canada? Well, you can bet that a lot of realtors were pretty excited to see the cut this week. The housing market has essentially stagnated over the last two years. There's a lot of people who cannot qualify for mortgages at the current high interest rate level. Lots of sellers who've been sitting on the sidelines because they don't know where the market's going to go. They don't know where prices are going to go. So waiting until they can potentially get a better price is the idea?

Yeah, they're waiting. They're waiting to see the direction of the market. Nobody wants to be the sucker that bought or sold at the exact wrong time. So what the impact of that's going to be on home prices remains to be seen. There's certainly, usually when interest rates start coming down, that typically pushes up house prices. More potential buyers coming to the market means more people bidding for houses. So that affordability problem, that is rooted in big, broad structural supply and demand issues. There is a lot of demand for homes in this country, there's rapid population growth, and there is a chronic undersupply, not enough homes are being built. So interest you know, interest rates can impact market dynamics.

But at the end of the day, you're not going to solve affordability by cutting interest rates a couple of times. So during the announcement on Wednesday, Bank of Canada Governor Tim Macklem also talked about the US's central bank. So I want to ask you about this, Mark. The US's central bank is called the Federal Reserve. And he talked about how its decision can affect our interest rate. We can gear monetary policy to the needs of the Canadian economy. So we don't need to move lock and step with the Federal Reserve. There are limits to how far we can diverge from the United States, but we're not close to those limits. Mark, just help me understand this.

What are these limits that Macklem is talking about? So it has to do with the Canadian US dollar exchange rate. So if the Bank of Canada starts cutting interest rates and the Federal Reserve does not start cutting interest rates, you are going to get downward pressure on the Canadian dollar. That's good news if you are going to get downward pressure on the Canadian dollar. That's good news if you are an exporter. It's not good news if you're an importer. And if you start devaluing the Canadian dollar or start pushing the Canadian dollar downwards, that can push up the price of imports and that can have an impact on inflation. So right now there's about half a percentage point

after this week's cut between the Fed's interest rate and the Bank of Canada's interest rate. Yeah, we should say the Fed's at what, 5.5% right now? Yeah, it's a range of 5.25 to 5.5. They use a range. But I've seen economists argue you could get up to a full percentage point difference before you start having to really worry about the Canadian dollar dipping below 70 cents to the US dollar right now, we're in the kind of 72, 73 cent range. So the kind of big picture background is the US economy is much stronger right now than the Canadian economy and inflation is much more stubborn in the US than it is in Canada. And so the US Federal Reserve is likely going to start cutting

interest rates later in the year, as opposed to over the summer. So markets right now are kind of betting potentially on a Fed rate cut in September, but it could be pushed back even later. So that's essentially the potential divergence there is if the Fed doesn't start cutting to later in the year and Bank of Canada gets a couple of cuts down the road, then you could start seeing that showing up in the Canadian dollar exchange rate. So are other countries' central banks also cutting rates or is Canada kind of an outlier here? So Bank of Canada is the first G7 central bank to start easing monetary policy. It is very likely that the European central bank is going to cut interest rates on Thursday. They've signaled that pretty clearly.

You've had some smaller European central banks like the Swedish Riksbank and the Swiss National Bank. They have both started lowering interest rates. The Bank of England might go this summer. So the Fed is the big outlier, and that's probably going to hold off until later in the year. Just in our last few minutes, Mark, let's look ahead here at what the Bank of Canada might do in the coming year. So what can we expect from interest rates over, I guess, the rest of this year and even into next year? Yeah, so Tiff Macklem said interest rates are likely going to continue coming down as long as inflation keeps trending in the right direction. It is probably going to be a slow and relatively gradual process. He has been talking quite a lot in recent months and he repeated it this week. And I want to stress this, the timing of any further cuts is going to depend on incoming data.

They also shouldn't expect interest rates to fall to the levels, the very low levels seen either during the pandemic or in that decade before the pandemic between the financial crisis and the pandemic. So we're not going to see 0.25 interest rate levels anytime soon then? Yeah. I mean, you could if there's an emergency, if we get to a nuclear war or another pandemic, or if a bunch of banks start collapsing, if an emergency strikes and the economy is on the brink, the Bank of Canada may very well cut rates rapidly. So that's not what the Bank of Canada expects.

They expect to lower rates relatively gradually. Right now, markets are expecting two more rate cuts this year. Most economists have penciled in two more rate cuts this year as well. So that would bring the policy rate down to 4.25% by the end of the year. If the economy takes a turn for the worse, if those mortgage resets, which are going to see some pretty large payment shocks in the coming year or two, if those start to bite harder, you could see the Bank of Canada pick up the pace and cut interest rates more. But certainly their message today was expect rates to come down relatively gradually. You know, Tiff Macklem in the press conference used the metaphor of landing a plane.

The plane hasn't been landed yet, so we're not cheering yet. But, you know, I would say the runway's in sight, but, you know, we still need to land this. So the Bank of Canada is not popping champagne bottles yet, but things are certainly developing the way they want them to develop. And that's got us to where we are this week, which is a pretty monumental shift in economic policy and a historic moment that kind of caps off several turbulent years for the central bank. Mark, always great to talk to you. Thank you so much for being here. Thanks so much for having me on. That's it for today. I'm Maina Karaman-Wilms. Our interns are Aja Sauter and Kelsey Arnett. Our associate producer is Manjot Singh.

Our producers are Madeline White, Cheryl Sutherland, and Rachel Levy-McLaughlin. David Crosby edits the show. Adrienne Chung is our senior producer, and Matt Frainer is our managing editor. Thanks so much for listening, and I'll talk to you soon.