Bank of Canada cuts interest rate by half point to 3.75%

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The Bank of Canada dropped its policy rate by 50 basis points on Wednesday, bringing the interest rate down to 3.75 per cent, as policymakers try to keep inflation near their target with a fourth consecutive rate cut.

“We took a bigger step today because inflation is now back to the two per cent target and we want to keep it close to the target,” Bank of Canada governor Tiff Macklem said during prepared remarks in Ottawa. “Today’s interest rate decision should contribute to a pickup in demand.”

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He said there was a “clear consensus” among governing council members that it was appropriate to cut by 50 basis points this time.

The decision to make a larger cut comes after the consumer price index hit 1.6 per cent in September, which was below the central bank’s inflation target. The slow growth in prices was driven mainly by a drop in energy prices, but policymakers now expect inflation to remain close to its target over the projected horizon.

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The Bank of Canada’s move was widely expected by economists, who think the problem policymakers now face is a weakening economy and deflation.

“Rate cuts will boost the economy with a lag,” Claire Fan, an economist at Royal Bank of Canada, said in a note to clients. “Even with interest rates moving lower, many borrowers can continue to expect debt payments to go up in the years ahead. That speaks to more urgency to ‘front-load’ the easing.”

The Bank of Canada expects gross domestic product (GDP) to have grown by 1.5 per cent in the third quarter, which is below the 2.8 per cent it projected back in July. The unemployment rate hit 6.4 per cent in September, driven mainly by the labour force growing at a faster pace than hiring, disproportionately hitting youth workers.

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“After stalling in the second half of last year, the economy grew by about two per cent in the first half of this year, and we expect growth of 1.75 per cent in the second half,” Macklem said. “The economy remains in excess supply and the labour market is soft.”

David Rosenberg, founder and president of Rosenberg Research & Associates Inc., said a poor Canadian economy has given the Bank of Canada the “green light” to stay dovish, despite the United States Federal Reserve signalling a less hasty easing path.

Growth is still expected to pick up at 2.1 per cent in 2025 and 2.3 per cent in 2026. The Bank of Canada also expects GDP per capita to pick up next year, with a slowdown in population growth and consumption per person rising due to lower interest rates and higher household wealth. The amount of capital per worker is anticipated to pick up as investment increases next year.

“This forecast largely reflects the net effect of a gradual pick-up in consumer spending per person and slower population growth,” Macklem said. “Business investment is expected to strengthen as demand picks up, and exports should remain strong, supported by robust demand from the United States.”

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Export growth is expected to be one of the key contributors to growth next year, boosted by the Trans Mountain Pipeline expansion.

There are risks to the central bank’s projections, including inflation, despite the recent cooling. Policymakers are concerned that lower interest rates could fuel a stronger rebound in housing and that wage growth could continue to outpace inflation and remain higher than productivity.

Currently, wage growth is around four per cent, but the central bank expects it to moderate over the next year as the labour market continues to cool. A potential wider conflict in the Middle East could also impact Iran’s oil production, presenting a risk of higher oil prices.

However, household spending could come in weaker than what the Bank of Canada is expecting, which could lead to lower investment by businesses and put further downward pressure on inflation.

Dawn Desjardins, chief economist at Deloitte Canada, said much of the central bank’s forecast on rebounding consumption is based on the labour market holding steady.

“Now, the big question that we’re thinking about is whether this is predicated on the labour market managing to hold in,” she said. “As long as that remains intact, I think we could anticipate, or we should anticipate, a pickup in consumption activity as we go through 2025, but really to me that’s the key factor.”

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Looking ahead, Macklem said policymakers will take their interest rate decisions one meeting at a time, but further reductions to the policy rate should be expected.

“The timing and pace of further interest rate cuts will depend on incoming information and our assessment of its implications for the inflation outlook,” he said.

In the meantime, the Bank of Canada’s policy rate remains in restrictive territory. According to its MPR, the neutral rate is estimated to be in the range of 2.25 per cent to 3.25 per cent, with economists split on when it will hit that range.

That said, Rosenberg said policymakers are cautioning markets not to expect a series of jumbo rate cuts.

“The path of future rate cuts may be open for debate, but the destination is not,” he said in a note. “Even after today’s 50 beeper, the policy rate is still 100 basis points north of where the central bank’s own midpoint estimate of neutral resides.”

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