Canada becomes the first G7 country to make the rate reduction effective

Canada becomes the first G7 country to make the rate reduction effective

The Bank of Canada cut interest rates by a quarter of a percentage point, becoming the first Group of Seven central bank to begin an easing cycle.

Monetary policymakers, led by Governor Tiff Macklem, lowered the benchmark interest rate to 4.75% on Wednesday, as markets and economists expected in a Bloomberg survey. The authorities are more confident that inflation is heading towards the 2% target, and affirm that it is “reasonable to expect further cuts” if progress continues.

“With more evidence that core inflation is easing, monetary policy no longer needs to be as restrictive,” Macklem said in prepared remarks. Canadian bonds rose after the cut. The Canadian government's two-year bond rate fell 5.9 basis points. The Canadian dollar depreciated to CAD$1.3729 per US$1.

The bank indicated that the path of easing will depend on the progress of inflation, which “will likely be uneven.” Potential risks to the outlook include global tensions, a faster-than-expected rise in house prices and high wage growth relative to productivity.

“We do not want monetary policy to be more restrictive than necessary to return inflation to its target. But if we lower our policy rate too quickly, we could jeopardize the progress we have made,” Macklem said.

It is the Bank of Canada's first rate cut since 2020. With this, the bank shows that it is increasingly confident that it is closer to declaring victory over inflation, which has fallen at an annual rate of 2.7% after reaching its maximum in mid-2022. This allows interest rates to begin to normalize after one of the most aggressive cycles of increases in the history of the central bank.

“It has only taken the central bank 11 months to go from increases to cuts, but this cycle is very different. In fact, “The official interest rate has this time reached much more restrictive levels than those seen in recent decades.”Royce Mendes, managing director at Desjardins Securities, wrote in a report.

Still, there is uncertainty about how quickly borrowing costs will fall. Along with the risks to the inflation outlook, the Bank of Canada has been ahead of the Federal Reserve. Historically, interest rates in both countries have tended to follow a similar path, and when they don't, some pressure is put on the currency. A weak Canadian dollar means higher import costs, with the risk of higher inflation. Macklem has said there are limits to the divergence between his central bank and its US counterpart.

The Bank of Canada's cut decision comes a day before the European Central Bank does the same, making it the first in the G7 to begin an easing cycle. The Canadian central bank joined the Swiss National Bank and the Swedish Riksbank in adopting more expansionary policy as inflation risks ease.