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Why did Canada slash interest rates? Expert insights

Why did Canada slash interest rates? Expert insights

The hopes for interest rate cuts were highly discussed in the U.S. in late 2023 and were, arguably, a significant driver of the stock market rally seen in the last 6 months.

Despite the optimism and inflation being driven down to more manageable levels, FED’s fund rate remained steady, and talk of further increases reemerged.

Unexpectedly, the U.S.’ northern neighbor, despite receiving significantly less attention in the international press, might have finally inaugurated a new era on Wednesday, June 5, as Canada’s Central Bank announced its first rate cut since the COVID-19 pandemic.

Why is Canada lowering interest rates?

The decision received relatively little official analysis, but it appears that the Crown elected to start laying the groundwork for a soft landing rather than risk a recession

The interest rate reduction – amounting to 25 basis points and bringing the rate to 4.75% – was largely facilitated by a significant and steady drop in inflation with recent trends showing that the CPI changes are near their usual averages.

One economist, David Macdonald, believes that the July announcement will offer significantly more information and provide for greater insights into the coming moves of both Canada’s Central Bank and the Canadian economy.

Furthermore, the Crown is expected to implement at least one more rate cut before the end of 2024.

An immediate reaction came from Canada’s housing market as the real estate industry commented that the interest rate cut had heightened enthusiasm among prospecting home buyers.

Nonetheless, it remains unclear whether the most recent Central Bank decision will lead to a reduction in prices or if the expected deluge in prospecting buyers will continue driving prices up.

What does Canada’s decision mean for the rest of the world?

The rate cut in Canada also sparked a more global conversation, given it is the first G7 economy to have implemented such a measure. Indeed, there are wide expectations that the European Central Bank (ECB) will follow suit in its Thursday, June 6 decision.

The situation is less clear when it comes to the United States. 

While the most recent CPI prints demonstrated that inflation once again stopped rising after a period of reheating in the transition between 2023 and 2024, the FED has, at best, been sending mixed signals. 

Chair Jerome Powell, for his part, signaled the Central Bank’s willingness to retain high rates as long as is needed.

On the other hand, pressure to lower the fund rates has been rising despite some voices, such as FED’s Kashkari, recently opining that further hikes should not be ruled out.

A hint that the U.S. may indeed have to continue bearing with high rates comes in the form of a recent International Monetary Fund (IMF) warning that the country’s recent outperformance of other advanced economies is the result of unsustainable fiscal policy.

While the IMF’s warning mostly pertained to America’s debt – which has been growing at alarming rates for years – it fits within the broader context of paradoxes found in the U.S. such as the fact that interest rates are at decade highs at the same time when major stock market indices such as the S&P 500 are at their own record highs.

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