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Cooling CPI Signals Potential Rate Cut by Bank of Canada

Digital stock market board displaying fluctuating prices and financial terms, including "RATE CUTS," in green and white text on a black background.

According to an Edge Realty report for May 2024, there is a strong possibility that the Bank of Canada will implement an interest rate cut in June, with a cut in July appearing almost certain, as core inflation fell within the Bank of Canada’s 1% to 3% target range for the first time in three years last month. 

The report further suggests that the Bank of Canada would have been waiting for two key developments before proceeding with a rate cut. The BOC would need to have seen a sustained decline in core CPI that suggested a continuing trend and a noticeable decrease in inflation expectations.

It predicted that the upcoming release of the Survey of Consumer Expectations in July would reveal a drop in inflation expectations, trending in the “right direction”, which would support rate cuts.

A line graph showing consumer expectations for inflation from 2015 to 2024, peaking around 6.5% in 2022 and decreasing to about 5% by 2023.

Source: Edge Realty

However, the key focus that the Bank of Canada is likely focussing on is core CPI, which seems to have been successfully achieved. Key measures of core inflation dropped significantly in April to 2.7%, down from 3.0% previously. This marks the eighth consecutive month of deceleration and the first time these key measures have returned to the 1% to 3% target range since July 2021. Additionally, the three-month change is currently at 0.5%, equating to an annualized rate of approximately 2%.

Line graph showing Core Inflation Measures (average CPI common, median, trim) from 2000 to 2024. Inflation was stable around 2% until a sharp increase around 2021, peaking at about 6% before declining.

Bar chart showing the seasonally adjusted 3-month change in core CPI from January 2021 to January 2024, peaking around mid-2022 and generally declining thereafter.

Source: Edge Realty

Headline inflation also cooled to 2.7% from 2.9%. However, it is useful to consider mortgage interest costs separately, as most other countries do. When these costs are excluded, inflation can be seen to have consistently been at 2% over the past four months.

Line graph depicting annual change in Consumer Price Index for Canada from 2002 to 2024, showing inflation peaking around 2022 and generally fluctuating between 0% and 4% over the years. Source: Statistics Canada.

Bar chart showing headline inflation ex-mortgage interest costs from January 2021 to April 2024. Inflation peaked around July 2022 at 8%, then gradually declined to around 3% by April 2024.

Source: Edge Realty

Despite these positive inflation trends, there has been a concerning drift in interest rate path projections over time. At the beginning of the year, markets anticipated a cumulative 1.25% in rate cuts for 2024, with the first cut expected in March. Currently, expectations have decreased to just 0.5% in cuts, likely starting in July. Looking further ahead, there are predictions that the Bank of Canada’s key rate will be 3.5% in 2026, eventually bottoming out at 3.0% in 2028.

Graph showing the implied Bank of Canada (BoC) policy rate path from Jan 2024 to Dec 2024 with May projections in black and December projections in blue. Source: 1-month CDOR rate forward contract.

A bar graph titled "5-year Bank of Canada policy rate outlook" shows rates starting at 5.25% today, dropping to 4.5% in 1 year, 3.75% in 2 years, 3.5% in 3 years, 3.25% in 4 years, and 3% in 5 years.

Furthermore, interest rates may be being influenced by the strength of the U.S. economy, despite signs of strain in Canada. This is particularly evident in metrics such as per capita GDP.

A bar chart comparing the quarterly real GDP per capita growth between the US and Canada from Q1 2022 to Q1 2024. Each period shows positive or negative growth figures for both countries.

It appears efforts to control inflation are showing signs of success. However, there are continuing concerns, with key regulators like OSFI now warning about the serious impacts of high interest rates on consumers. OSFI anticipates that higher borrowing costs will lead to increased mortgage renewal risk, reduced consumer spending, and lower business investment. The Edge Realty report suggests that the Bank of Canada must consider these concerns. 

While a rate cut in July seems almost certain, there is a strong possibility of a cut on June 5 as well.

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