The central bank of Canada's policy turnaround: reducing interest rates and focusing on the soft landing of the economy (07/26/2024)
Summary
In its latest policy decision, the Bank of Canada sent a strong signal that it is changing its approach towards supporting economic growth by cutting interest rates by a quarter of a percentage point. The decision, the second in a row, shows that Canadian policymakers are increasingly concerned about slowing economic growth and believe that downside risks to the economy have outweighed them.
Changing the approach from curbing inflation to supporting growth:
In recent months, the Bank of Canada has been mainly focused on curbing inflation and has steadily raised interest rates to that end. But as concerns about inflation eased and signs of slowing economic growth emerged, policymakers decided to shift monetary policy toward supporting growth.
Reasons for lowering interest rates:
Easing Inflation Concerns: Recent data shows that Canada’s inflation rate is easing and inflation expectations have generally eased. This has reassured the central bank that price pressures are under control.
More downside risks: Policymakers believe downside risks to the Canadian economy have increased. These risks include a reduction in consumer spending, the extension of mortgage loans, and signs of a slowdown in the labour market.
Trying to soft-land the economy: The central bank is trying to soft-land the economy, meaning it wants to reduce inflation without causing an economic recession. Lowering interest rates can help revive growth and create employment.
Possible effects of this decision:
Enhancing economic growth: Lowering interest rates can reduce borrowing costs and thus contribute to more investment and consumption in the economy.
Increase in asset prices: A decrease in interest rates usually leads to an increase in the price of assets such as housing and stocks.
Weakening of the Canadian dollar: A decrease in interest rates can reduce the value of the Canadian dollar against other currencies.
Rising inflation in the long run: Although the central bank believes that inflation is under control, some economists are concerned that a cut in interest rates in the long run will lead to a rebound in inflation.
The Future of Canadian Monetary Policy:
The Bank of Canada has announced that it will take its decisions on a meeting-by-meeting basis and is ready to cut interest rates further if necessary. However, the bank still emphasizes the importance of long-term inflation stability.
Conclusion
The interest rate cut by the Bank of Canada represents a significant change in the country’s monetary policy. Canadian policymakers are trying to find a balance between supporting economic growth and maintaining price stability. However, the success of this policy depends on various factors, including global economic developments, government fiscal policies, and the behaviour of consumers and businesses.