Canada’s Economic Outlook: Navigating the Post-Cut Landscape

The Bank of Canada’s recent decision to cut interest rates marks a significant shift in monetary policy, altering the economic landscape outlined in the July 2024 Monetary Policy Report. This analysis explores the implications of these cuts and how they reshape Canada’s economic trajectory.

Inflation: A Tale of Two Sectors

The July report highlighted a divergence between goods and services inflation. With interest rate cuts now in play, this divide may narrow, but not disappear entirely:

• Goods Inflation: Already low at 0.3% in June 2024, goods inflation might see a slight uptick. Lower borrowing costs could boost consumer demand for durable goods, potentially pushing prices upward. However, global supply chains remain robust, likely keeping a lid on significant price increases.
• Services Inflation: This remains the wild card. While it was at 4.8% in June, the rate cuts could fuel further increases, especially in discretionary services. However, if the cuts successfully stimulate economic activity and ease supply constraints (particularly in housing), we might see some moderation in services inflation over time.

Housing Market: A New Foundation

The housing market, long constrained by high interest rates and supply issues, may see the most dramatic shifts:

1. Demand Surge: Lower mortgage rates are likely to reignite demand, particularly among first-time homebuyers who were previously sidelined.
2. Construction Boost: The July report projected residential investment growth of 8% over 2025. With lower borrowing costs, this figure could be revised upward as developers find projects more financially viable.
3. Supply-Demand Balance: While increased construction will help, the structural supply constraints mentioned in the report (zoning issues, labor shortages) won’t disappear overnight. This could lead to a period of rising home prices until supply catches up.

Consumer Spending: Unleashing Pent-Up Demand?

The July report noted weak consumer spending, with GDP per capita contracting. The rate cuts could reverse this trend:

• Households with variable-rate mortgages will see immediate relief, potentially freeing up income for discretionary spending.
• Consumer confidence may improve, encouraging larger purchases that were previously delayed.
• However, the diversity of household financial situations noted in the July report remains. Some will benefit more than others from the rate cuts.

Labour Market: A Delicate Balance

The labour market had cooled significantly by mid-2024, with unemployment rising to 6.4%. The rate cuts could help stabilize or even tighten the job market:

• Businesses may feel more confident about hiring and expanding with lower borrowing costs.
• However, if inflation reaccelerates, real wage growth could stagnate, potentially limiting labour market improvements.

Risks and Uncertainties

While the rate cuts aim to stimulate growth and manage inflation, they introduce new uncertainties:

1. Inflation Resurgence: If the cuts overstimulate the economy, inflation could reaccelerate, forcing the Bank to reverse course.
2. Financial Stability: Lower rates could fuel excessive risk-taking in financial markets or real estate, potentially creating bubbles.
3. Currency Pressures: If the cuts are more aggressive than those of trading partners, it could put downward pressure on the Canadian dollar, affecting trade dynamics.
4. Global Uncertainties: The geopolitical risks mentioned in the July report remain, with ongoing conflicts and trade tensions potentially disrupting supply chains and commodity prices.

Conclusion: A Recalibrated Trajectory

The Bank of Canada’s rate cuts represent a recalibration of monetary policy in response to evolving economic conditions. While they address some of the concerns raised in the July 2024 report – particularly around weak consumer spending and housing market constraints – they also introduce new dynamics and potential risks.

As we navigate this new economic landscape, the key will be balancing growth stimulation with inflation management. The Bank’s ability to fine-tune its approach in response to incoming data will be crucial in achieving a soft landing for the Canadian economy.