How Soon Should We Expect the First Rate Cut?

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The Bank of Canada held its rate steady on January 24 for a fourth consecutive meeting, and for the first time stated directly that it won't need to raise rates again if the economy continues developing in line with its forecasts.

The central bank's leadership, headed by Tiff Macklem, left the benchmark overnight rate unchanged at five percent on Wednesday, January 24, a pause that markets and economists surveyed by Bloomberg had widely expected. The Bank says its data show economic growth has stalled and will remain sluggish in the near term, which should help bring inflation back to the Bank's two percent target next year. "There was clear consensus around holding our policy rate at five percent," Macklem said in his prepared opening remarks at the press conference. "In the Governing Council's discussions, the focus of future policy debate is shifting from whether monetary policy is restrictive enough, to how long we need to maintain the current restrictive stance."

The "softer" tone of the statement suggests the Bank sees the economy slowing quickly and believes past rate increases, 475 basis points (4.75%) in under two years, are enough to bring inflation under control. That potentially opens the door to rate cuts in the coming months. "If the economy evolves broadly in line with the forecast we published today, I expect future discussions will focus on how long we hold the policy rate at five percent," Macklem noted.

The Bank wants to see "further and sustained easing" in core inflation, and will continue to focus on the balance between supply and demand in the economy, inflation expectations, wage growth, and corporate pricing behaviour, the Bank's statement said. Its forecasts suggest the economy is currently running in a state of "modest excess supply," which is why the Bank lowered its growth forecast for this year to 0.8 percent from 0.9 percent. That said, the Bank of Canada's base-case scenario still points to a "soft landing," with growth expected to pick up around the middle of the year.

The Bank expects inflation to stay close to three percent through the first half of 2024, before easing to roughly 2.5 percent by year's end and returning to the Bank's two percent target the following year. The Consumer Price Index accelerated to 3.4% year-over-year in December, and has stayed above the upper bound of the central bank's 3 percent target range for 32 of the past 33 months. The Bank of Canada's closely watched core inflation measures have also risen. "Over the projection horizon, ongoing excess supply in the economy continues to weigh on prices, while corporate pricing behaviour and inflation expectations gradually normalize," the Bank's Monetary Policy Report states.

Wage growth, still running at 4-5% annually, is expected to slow, moving closer to inflation and modest productivity growth, the central bank said. That said, shelter price inflation will remain "elevated for some time," with the pace of mortgage interest cost growth gradually slowing as financial conditions ease and as fewer additional households renew or take out new mortgages. Rent inflation, driven by strong housing demand and constrained supply, is expected to ease as population growth slows and new home construction is expected to pick up.

Stronger-than-expected home price growth is one of the main risks that could push inflation above expected levels, the Bank noted.

Canada's economy is more sensitive to interest rates than its peers, given higher household debt loads and shorter mortgage terms. Most economists expect the Bank of Canada to cut its policy rate by June, and traders in the overnight swaps market are pricing in similar expectations.

Dawn Desjardins, Chief Economist at Deloitte Canada, said the decision to hold rates steady shows the Bank remains "cautious" and "patient" in pursuing its inflation target. "They're still being careful, they keep saying (inflation) needs to develop the way we think it will, and that's entirely fair," Desjardins told Bloomberg. Desjardins is looking to spring as the point when Canadians could see the Bank of Canada's first rate cut. "The first cut will most likely come in the second quarter. Now, whether that's April or June is certainly an open question, and it'll really depend on what we see in upcoming inflation reports," she said.

Ed Devlin, founder of Devlin Capital and Senior Fellow at the C.D. Howe Institute, said he believes the first rate cuts will come in June, with four cuts of 25 basis points each expected over 2024 (1% total). "Markets are pricing in 1%, and I don't have a major disagreement with that, we'll see how the data unfolds," Devlin noted. It's worth remembering here that the commercial banks' Prime rate currently sits at 7.20%, and if the Bank of Canada cuts its key rate by 1%, Prime will likely fall to 6.20% by the end of 2024 as well. That would mean substantial relief for holders of variable-rate mortgages and home equity lines of credit (HELOCs). Meanwhile, anyone considering a new mortgage today and leaning toward a variable rate will likely see it converge with today's fixed-rate products by year's end, and stand to benefit increasingly over the following 4 years as the Bank of Canada continues cutting rates.

The Bank of Canada's next meeting is scheduled for March 6.

As we noted above, experts say there's good reason to believe rate cuts will most likely arrive in spring or summer. That would ease pressure on mortgage holders, but it could also open the floodgates for more homebuyers and investors to enter the market, driving a sharp rise in home prices. Prospective buyers suddenly find themselves stuck "at the starting line," unsure of the best way to time their entry into the market, with some feeling the urge to act quickly now that prices have only just stabilized, while others wait for rate cuts to begin.

While experts still disagree on just how much further home prices could climb, many note that increased interest from a growing pool of prospective buyers has already been building since the start of the year. Some point out there's a sense that once rates come down, rising demand for real estate will push Toronto back toward a balanced market (it's been a buyer's market since last September), with sales recovering from last year's downturn, the lowest since 2000.

In 2023, sellers were reluctant to adjust to the market, pricing homes too high, which led to fewer offers and longer time on market. Now, sellers are pricing homes in line with current conditions, rather than pandemic-era record highs. That said, buyers still aren't rushing, they're stepping in "with caution," not yet feeling pressure to buy urgently. Many are taking a wait-and-see approach tied to interest rates. Sellers are waiting for their moment too. Once rates fall, we could see supply increase, since many sellers who've been sitting on the sidelines will need to list their properties.

Some economists forecast that the moment the Bank of Canada even signals upcoming rate cuts, that alone will boost sales and push prices higher. "We won't see rates as low as during the pandemic, so there won't be panic buying again," said Philip Cross, Senior Fellow at the Macdonald-Laurier Institute and former Chief Economist at Statistics Canada. "But we've already seen the market stabilize once the Bank said it wouldn't raise rates further, imagine what happens once it actually cuts them."

In March 2023, when the Bank of Canada announced it was pausing rate hikes, the spring market saw a burst of sales, activity, and rising home prices. When rate hikes resumed in June and July, market activity slowed again, showing just how sensitive the market is not only to rate increases and decreases, but to pauses as well, Cross added. If the Bank of Canada only cuts rates once or twice, adding up to a total drop of 50 basis points (0.50%), the actual change in mortgage payments for most people will be minor, but it will still shift the psychology of first-time buyers, the group hit hardest over the past few years.