It's a start

Expectations for an early Bank of Canada rate cut strengthened after last week's report of tepid GDP growth in Q1, and today the Bank duly delivered, cutting its overnight target rate by 25 basis points, to 4.75 percent.  This is the first change in the target rate since the Bank ended its tightening cycle in July 2023.

Taking the media release and Governor Macklem's press conference opening statement together, it is evident that the Bank's confidence in continuing easing in inflation has grown in recent months. In the opening statement, Gov. Macklem highlighted four reasons for this belief:

• CPI inflation has eased from 3.4% in December to 2.7% in April

• our preferred measures of core inflation have come down from about 3½% last December to about 2¾% in April

• the 3-month rates of core inflation slowed from about 3½% in December to under 2% in March and April

• the proportion of CPI components increasing faster than 3% is now close to its historical average, suggesting price increases are no longer unusually broad-based.

In addition, the Bank believes the economy is operating in a state of excess supply, so that "there is room for growth even as inflation continues to recede".  It is not clear if the Bank sees evidence of that excess supply only in the labour market. It is certainly true that the unemployment rate has risen steadily in recent months, but that entirely reflects the explosive growth in the labour force resulting from high immigration. It is not yet clear whether the newcomers will quickly settle into productive employment, though the early signs are mostly promising. 

What next? Here we need to parse the Bank's statement carefully. Both the media release and the opening statement say that "monetary policy no longer needs to be as restrictive" (emphasis mine). This implies that it still needs to be somewhat restrictive, and indeed Gov. Macklem stressed that the Bank's future moves will be data dependent: "we are taking our interest rate decisions one meeting at a time". The Bank does not want to keep rates needlessly restrictive, but "if we lower our policy interest rate too quickly, we could jeopardize the progress we’ve made".

This is the vaguest possible forward guidance, and quite deliberately so. The Bank is happy for markets and the general public to conclude that the tightening cycle is over and the easing cycle has begun, but it is not committing itself to any timeline. The emphasis on excess supply suggests that employment figures will be as important as inflation data in determining the pace of easing, and the Bank also has to keep a wary eye on policy developments at the Federal Reserve. At this juncture it looks likely that the Bank will deliver two more 25 basis point rate cuts in the second half of the year.