The Bank of Canada’s decision to cut its key interest rate by a whopping half a percentage point is welcome news for Canadians who have struggled under higher borrowing costs and punishing inflation.
While the rate cut can be seen as a positive sign that inflation has been brought under control, earlier historical periods that saw the rate lowered by 50 basis points in response to economic turmoil could indicate other considerations as well.
The central bank on Oct. 23 reduced its key interest rate for the fourth time in 2024, bringing it down from 4.25 percent to 3.75 percent. Bank of Canada governor Tiff Macklem said the bank took a “bigger step” to cut the rate because “inflation is now back to the 2 percent target and we want to keep it close to the target.”
September’s year-over-year inflation number came in at just 1.6 percent, while October’s inflation number is expected to be 2 percent.
Further Rate Cuts Likely
Doug Porter, managing director and chief economist at BMO, said the move can be seen as a “bit of a declaration of victory” in the bank’s fight against inflation. “They’re not going to take a lot of victory laps here. They’re not going to quite say ’mission accomplished,' but it’s a pretty important day from that standpoint,” he said.The Bank of Canada first began raising interest rates in early 2022 after inflation spiked in response to the COVID-19 pandemic, disrupted supply chains, increased government spending, and higher energy prices. Inflation rose from 2.2 percent in March 2021 to as high as 8.1 percent in June 2022, while the bank increased its rates from 0.25 percent in March 2022 to a peak of 5 percent in July 2023.
Discussing the interest rate decision at a press conference on Oct. 23, Macklem said household spending and business investment have picked up this year but “remain soft,” and that the larger rate cut should encourage stronger demand and economic growth. He said if the economy continues to grow broadly in line with the bank’s forecast for inflation and demand, further interest rate cuts could be expected.
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Porter said that while he believes further rate cuts are likely in the months ahead, “fundamental” changes in the economy mean it’s unlikely rates will fall to extreme lows of less than 1 percent. He said such low rates, which came after the 2008 global financial crisis, were “not normal.”
“If something really extraordinary happens, like a major geopolitical shock, it’s possible. But barring some kind of huge shock like that, I don’t think we’re going to return to those extreme levels,” he said.
James McNeil, an economics professor at Dalhousie University, said the central bank’s decision to cut its rate by half a percentage point was “not unexpected” given the current inflation numbers. McNeil also said the decision to cut by such a large amount was influenced by the U.S. Federal Reserve, which recently cut its rate by a half point in September.
“It’s not as if the central banks are in coordination, but if U.S. monetary policy were to remain tight and the Bank of Canada were to loosen a lot, that would potentially lead to a larger depreciation of the exchange rate, which would then be inflationary through imports,” McNeil said.
Larger Cuts Typically Done in ‘Emergency Situation or Crisis’
Porter acknowledged that the Bank of Canada’s larger interest rate cut is a move that’s typically been done in reaction to “an emergency situation or crisis.”The central bank lowered its rate from 3.5 percent to 2.75 percent in October 2001, following the 9/11 terrorist attack that year. It further reduced the rate to 2.25 percent in November 2001 and to 2 percent in January 2002.
During the 2008–09 financial crisis, which was triggered by excessive risk-taking by financial institutions and the bursting of the U.S. housing bubble, the Bank of Canada responded with a half-percentage-point rate cut in March 2008 and the same in April and early October, bringing the rate from 4 percent down to 2.5 percent.
This was followed by a quarter-percentage point cut later in October 2008, a three-quarter-percentage-point cut in December 2008, and another half-percentage-point cut in January 2009, when the bank said Canada’s economy was in recession and “projected to contract through mid-2009.” From 1 percent at that time, a further half-percentage point cut in March 2009 and a quarter-percentage-point cut in April 2009 brought the rate down to 0.25 percent.
The key rate was 1.75 percent at the start of 2020. Due to the COVID-19 outbreak, the Bank of Canada responded by cutting the rate three times in March that year, lowering it from 1.75 percent to 0.25 percent in response to “negative shocks to Canada’s economy arising from the COVID-19 pandemic and the recent sharp drop in oil prices.”
Porter said the most recent decision wasn’t done in reaction to a crisis but it’s “possible we’re going to get hit with something in the next year.” In its monetary policy report released Oct. 23, the central bank said its economic outlook is also “subject to increased geopolitical uncertainty” involving conflicts in the Middle East and Ukraine, the U.S. election outcome, rising trade tensions, and the potential for additional tariffs.
“I would say, if we did get hit with some kind of geopolitical crisis, then I wouldn’t be surprised if we did see some additional outsized rate cuts,” Porter said.
Porter also said Canada’s declining per capita GDP is “fundamentally a reason why they think it’s reasonable” to cut interest rates. That metric has fallen in six of the past seven quarters, according to a July Royal Bank of Canada (RBC) report, which said that falling per person output along with a rising unemployment rate are situations similar to what usually occurs during a recession.
