Bank of Canada Council split on timing of future rate cuts

On April 10, the Bank of Canada (BoC) announced it was holding its trend-setting Overnight Lending Rate – the benchmark used to set the Prime rate and, by extension, variable mortgage rates – at 5%, where it has remained since July 2023. While markets and analysts largely expected this latest rate hold, questions remain over when the central bank will start to lower rates, and how much they took improving inflation and other economic indicators into consideration when making their latest decision.

Well, we now have insight into what the BoC’s Governing Council were mulling over at the time, as they released their Summary of Deliberations this week, detailing their key discussion points and the rationale that led to keeping the current status quo.

Overall, it appears policymakers largely agreed that promising progress has been achieved in the core inflation metrics. Where they were divided, however, was just how much more assurance would be needed before they can make a downward move. The BoC wants to see Canada’s headline inflation rate consistently perform at their 2% target before rate cuts will be on the table; the most recent March inflation reading showed a year-over-year growth of 2.9%.

“In its communications on the previous two interest rate decisions, Governing Council had stressed it was looking for “further and sustained easing in core inflation,” reads the Summary. “Members agreed that the decline in core inflation in January and February was ‘further’ easing, and they wanted to see this easing ‘sustained.’”

Here’s a breakdown of the other key points considered by the Governing Council at the time of their rate policy decision.

BoC Council is split on how much longer they should hold rates

The good news is the Council is feeling “confident” that Canada’s inflation outlook is balanced. The Core CPI-trim and median metrics – the BoC’s preferred indicators when judging inflation’s progress – have shown steady improvement, coming in to just above 3% in February with their three-month measure trending down on an annual basis. Overall, the BoC expects inflation to hover around the 3% mark over the next few months, and lower to under 2.5% in the second half of the year.

Some of the council members were of the opinion that this, combined with a stable economy, meant they can hold out for longer on rates, with less risk that doing so would harm economic growth. There are also lingering risks that strong growth in the US could put pressure on inflation. As the summary reads, “They felt more reassurance was needed to reduce the risk that the downward progress on core inflation would stall, and to avoid jeopardizing the progress made thus far.”

Other policy makers, however, said enough progress on inflation has been made. Coupled with “indicators that the economy was in excess supply” (meaning more goods and services are being produced than there is demand for), delaying rate cuts further may be too restrictive, and could slow the economy more than necessary.

They’re keeping a close eye on the US economy

Historically, the BoC tends to follow the trends set by the American central bank, the US Federal Reserve. This is because, as the Canadian and US economies are so intricately linked, deviating too far from each other on interest rate direction could overly weaken the Loonie. However, they way things are shaping up, the BoC will be in a rare position to cut rates before the Fed is ready.

This is because the US economy continues to run hotter than Canada’s with jobs, GDP, and inflation data remaining stubbornly high despite the rate hikes delivered by the Fed. This in turn could strengthen Canada’s trade industry (which will heat our inflation). While not likely to deter the BoC from cutting rates this summer, US economic performance continues to be a closely watched catalyst.

High housing costs pose inflation risk

An interesting tidbit included in the summary was a discussion among members over whether rising real estate prices and demand – which fuel shelter inflation – pose a risk to their progress. They agreed that cutting interest rates will be inflationary, as more home buyers will enter the market due to lower borrowing costs, regardless of when rate cuts occur.

They also considered how mortgage interest costs (MIC) “should be treated from a monetary policy perspective.” This metric represents rising mortgage payments for borrowers, as a result of the BoC’s own rate hikes. MIC is the largest single contributor to inflation’s growth, and poses a bit of a catch-22 for the bank; as they hike rates to cool inflation in other CPI categories, MIC will rise. Ultimately, though, the Council decided that looking at their favoured CPI-trim metric effectively allows them to “look through mortgage interest costs.”

“CPI-trim symmetrically filters out extreme price movements at both the bottom and top of the distribution of price changes. Mortgage interest costs had thus been excluded from CPI-trim in almost every month over the past two years. However, CPI-trim had still captured other shelter services prices, such as rent, which are more reflective of demand for and supply of housing,” states the summary.

Rapid immigration could impact inflation

The Council also noted that current immigration targets could have unexpected impacts on inflation and GDP, especially in terms of demand for housing.

“Members discussed in detail the impact of population growth on their outlook. They agreed that the rapid increase in the population, as well as the future decline in the share of non-permanent residents announced by the federal government, complicated the outlook for economic activity and inflation,” states the summary. 

“Since population growth adds to both supply and demand in the economy, the impact on inflation will likely vary across components of the consumer price index (CPI). Governing Council members agreed that, given the existing imbalance in the supply of and demand for housing, and the fact that an expansion in housing supply takes time, the increase in population added to the short-term pressure on shelter inflation, including rent and components linked to housing prices.”

Rate cuts will be slow and steady

Overall, the Council agreed that once rate cuts do kick off, they’ll do so at a gradual pace; the way down will be much slower than the way up. 

“While there was a diversity of views about when conditions would likely warrant cutting the policy rate, they agreed that monetary policy easing would probably be gradual, given risks to the outlook and the slow path for returning inflation to target,” reads the summary.

And when it comes to those cuts, June remains the most likely timing, according to BMO’s Managing Director, Canadian Rates & Macro Strategist Benjamin Reitzes.

“The Bank of Canada wants to see "sustained" easing in core inflation,” he wrote in an economic note on April 24. “ Since the April 10 policy meeting, March CPI came in soft, building on the inflation progress seen in the prior two months. If we get a fourth straight subdued CPI report next month, it looks like the BoC will strongly consider cutting policy rates in June. Beyond that, it's clear that rate cuts will be gradual, and that the BoC is in no rush to get back to neutral.” 

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