Bank of Canada cuts rates for first time in four years as inflation eases

After keeping rates at a more than two-decade high of five percent, the BoC said indicators for underlying inflation improved.

The Bank of Canada has trimmed its key policy rate by 25 basis points to 4.75 percent, in a widely expected move that marked its first cut in four years, and said more easing was likely if inflation continued to ease.

After keeping interest rates at a more than two-decade high of 5 percent for almost a year, on Wednesday the BoC said the indicators for underlying inflation looked increasingly positive.

“With further and more sustained evidence underlying inflation is easing, monetary policy no longer needs to be as restrictive,” Governor Tiff Macklem said in his remarks after the announcement.

Financial markets immediately priced in a 42 percent chance of a cut to 4.5 percent next month, and a cut in September was fully priced in. A majority of economists polled by Reuters had expected Wednesday’s cut.

The Canadian dollar pared its early gains and weakened by 0.4 percent to 1.3733 to the United States dollar, or 72.98 US cents after the decision.

The BoC joins Sweden’s Riksbank and the Swiss National Bank in bringing down rates that have burdened households and businesses alike, and muted economic growth amid easing price pressures.

The European Central Bank is most likely to follow suit on Thursday, financial markets foresee.

Inflation in Canada has slowed this year to hit a three-year low of 2.7 percent in April. While inflation has stayed below 3 percent for four months in a row, it is still higher than the BoC’s 2 percent target.

“If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2 percent target continues to increase, it is reasonable to expect further cuts to our policy interest rate,” Macklem said in an indication of what future reductions could look like.

“But we are taking our interest rate decisions one meeting at a time,” he added.

Macklem, who has repeatedly cautioned Canadians that rates will not fall as fast as they rose, said further progress in combating inflation was likely to be uneven and risks remained.

“We have increasing confidence that the Bank of Canada will move again in July,” Royce Mendes, head of macro strategy for Desjardins Group, wrote in a note.

Andrew Grantham, senior economist at CIBC, also said he expected a cut in July, adding that he foresees a total of four reductions this year.

The next rate announcement is due on July 24, when the bank will also release its latest quarterly forecasts.

Economic growth in the first quarter was slower than expected at 1.7 percent, helping boost market anticipation of a rate cut.

Macklem said the economy was operating in excess supply, leaving room for growth even as the overall inflation rate continued to drop.

He reiterated that the bank would remain focused on demand and supply mismatch, inflation expectations, wage growth and corporate pricing behaviour.