Bank of Canada and European Central Bank Expected to Cut Interest Rates This Week

In a move that reflects both the domestic economic landscape and broader global trends, the Bank of Canada (BoC) is widely expected to cut its benchmark interest rate by 25 basis points to 4.75% tomorrow.

This decision, anticipated by a significant majority of economists, could be the first of several rate cuts this year, potentially totaling up to four reductions.

The decision to cut rates is driven by a combination of factors. Canada’s inflation rate has been within the BoC’s target range of 1%-3% for several months, easing pressures on the central bank to maintain high interest rates. April’s annual inflation rate dropped to 2.7%, down from 2.9% in March, indicating a trend of disinflation that the BoC finds encouraging.

Moreover, the Canadian economy is showing signs of slowing down. Recent data from Statistics Canada revealed that GDP grew at an annualized rate of just 1.7% in the first quarter of 2024, well below the BoC’s projection of 2.8%. This slowdown in growth has bolstered the case for easing monetary policy to stimulate economic activity.

Don’t Expect the Fed to Follow Suit

One significant consideration for the BoC is the divergence in economic conditions between Canada and the United States. While the U.S. Federal Reserve is expected to hold off on rate cuts until at least September, the Canadian economy’s greater sensitivity to interest rate changes necessitates a more immediate response.

Unlike in the U.S., where many homeowners locked in low mortgage rates during the early pandemic, Canadian homeowners are now facing mortgage resets at much higher rates, straining household budgets and reducing consumer spending.

Douglas Porter, chief economist at BMO Capital Markets, commented:

“The door is open for a BoC rate cut, and we have been leaning to a June move. But it remains a close call, and when the Bank does eventually move, it will be gradual, with a highly patient Fed acting as a limiter on how far and how fast Canadian rates can fall.”

Real Estate Implications

A potential rate cut is expected to have significant implications for the real estate market. After months of stagnant prices, a reduction in borrowing costs could ignite a buying frenzy, particularly in hot markets like the Greater Toronto Area.

Real estate consultant John Andrew, who predicts residential real estate prices in the region could rise by up to six percent by year’s end if the BoC cuts rates, stated:

“If we do see a rate cut this week, it’s going to really, really jump-start the market. I think you’re going to see a lot more offers being made, and that inventory starting to come down.”

However, some economists caution that a series of rate cuts could inadvertently reignite property prices, putting upward pressure on living costs. Despite these concerns, current forecasts for house price inflation remain subdued, with a separate Reuters survey predicting median home prices will rise just 1.5% this year.

European Central Bank to Also Cut Rates

The BoC’s anticipated rate cuts align with actions by other major central banks, including the European Central Bank (ECB) and the Swiss National Bank, which have already begun easing monetary policy in response to cooling inflation. The ECB is expected to lower its deposit facility rate to 3.75% on Thursday, following a period of declining inflation.

Despite the international trend towards easing, the future path of interest rates remains uncertain. Some analysts warn that persistent inflation could complicate further rate reductions.

Konstantin Veit from Pimco commented:

“We doubt the ECB will provide a lot of guidance here, and expect it to re-emphasize its meeting-by-meeting approach based on the data flow over the coming months.”

Reuters Poll Results and Rate Cut Odds

A recent Reuters poll highlights the expected rate cuts by both the Bank of Canada and the European Central Bank. According to the poll, 75% of economists predict that the BoC will cut its key interest rate by 25 basis points to 4.75% on June 5.

This sentiment is echoed in the financial markets, which have priced in slightly more than a 60% chance of this move. The poll also indicates that the BoC is likely to cut rates three more times this year, though the extent of these cuts remains a close call among economists.

The European Central Bank is also forecasted to lower its rates during its upcoming policy meeting on Thursday. The Reuters poll, which surveyed 82 economists, found unanimous expectation for a rate cut at the ECB’s June 6 meeting.

The money markets have also reflected a 93% chance of a rate cut by the ECB, with the European Central Bank likely to lower the rate on its deposit facility to 3.75%. Similarly, according to market pricing, the odds of a 25 basis points rate cut by the BoC tomorrow is 82%.

Both central banks are among the first of the major financial institutions to ease monetary policy in response to recent economic data, setting the stage for a cautious but hopeful economic outlook.

As the Bank of Canada prepares to announce its rate decision, the economic landscape presents a mixed but cautiously optimistic picture. While disinflation and slower GDP growth support the case for rate cuts, the BoC will need to navigate potential risks, including the impact on real estate and the broader economic interplay with U.S. monetary policy.

Ultimately, the central bank’s actions will be closely watched as a bellwether for the Canadian economy’s trajectory in the months ahead.

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