Bank of Canada Cuts Interest Rate by 25 Basis Points as Expected

The Bank of Canada cut interest rates for the first time in four years, stating that "further rate cuts are expected to be reasonable" if inflation progress continues.

The Bank of Canada lowered the interest rate by 25 basis points, becoming the first central bank among the G7 countries to initiate an easing cycle.

On Wednesday, policymakers led by Bank of Canada Governor Tiff Macklem lowered the benchmark overnight rate to 4.75%, in line with market expectations. Officials said they are more confident that the inflation rate will move towards the 2% target, and indicated that "further rate cuts are expected to be reasonable" if progress continues.

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"There is further and more sustained evidence that inflation is easing, and monetary policy no longer needs to be as restrictive," Macklem said in a prepared speech.

After the Bank of Canada announced its interest rate decision, the US dollar rose nearly 50 points against the Canadian dollar in a short period, and the US dollar index gaped higher.

The Bank of Canada stated that the easing path depends on sustained inflation progress, and policymakers indicated that inflation progress "may be uneven." Officials pointed out that global tensions, faster-than-expected house price increases, and high wage growth relative to productivity are potential risks to the economic outlook.

Macklem said, "If we lower the policy rate too quickly, it could jeopardize the progress we have made."

The Bank of Canada's first interest rate cut since 2020 indicates that officials are increasingly confident that they are approaching a declaration of victory over inflation. After peaking in mid-2022, Canada's annual inflation rate has dropped to 2.7%. This allows Canadian policymakers to begin normalizing interest rates after one of the most aggressive tightening cycles in history.

Since the beginning of this year, the slowdown in inflation in Canada has been faster than expected. The April CPI annual rate slowed to 2.7%, while the bank's forecast for second-quarter inflation growth was 2.9%. Core inflation has also eased for four consecutive months, with the average of two core inflation figures in Canada reaching 2.75% in April.

However, there is still uncertainty about how quickly borrowing costs will decline. In addition to the risks facing the inflation outlook, the Bank of Canada has also taken action ahead of the Federal Reserve. Historically, the interest rate movements of these central banks have been largely consistent, and when they do not, the domestic currency faces some pressure. A weak Canadian dollar would mean higher import costs and bring higher inflation risks. Macklem has said that the divergence between the Bank of Canada and the Federal Reserve is limited.In general, Canadian policymakers believe that there is an excess supply in the Canadian economy, and wage pressures are gradually easing. However, consumer spending remained resilient at the beginning of this year, and the economy showed strong momentum before entering April, with the job market adding the most jobs in over a year in April.

In addition to the Bank of Canada, it is widely expected that the European Central Bank will also lower borrowing costs.

From now until the interest rate decision in July, the Bank of Canada will receive two more reports on inflation, employment, and retail data, as well as GDP data for April. Officials said they will continue to focus on demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behavior.

In addition, regarding the reduction of the balance sheet, policymakers said they will continue to implement quantitative tightening to normalize the balance sheet.