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Bank of Canada lowers interest rates to become the first G-7 central bank to ease policy

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  • The Bank of Canada has cut its main interest rate by 25 basis points to 4.75%, becoming the first G7 central bank to ease monetary policy in the current economic cycle.
  • The decision was driven by slowing economic growth and easing inflation, with the BoC expressing increased confidence in achieving its 2% inflation target.
  • Future rate cuts are possible but will be approached cautiously and depend on ongoing economic data and inflation trends.

The Bank of Canada (BoC) has made a significant move by cutting its main interest rate by 25 basis points to 4.75%, becoming the first central bank among the Group of Seven (G7) nations to ease monetary policy in the current economic cycle. This decision, announced on June 5, 2024, marks a pivotal shift in the global economic landscape, as other major economies continue to grapple with inflationary pressures.

The BoC's decision to reduce the interest rate comes after a prolonged period of high rates, which had been maintained at 5% for nearly a year. This move was widely anticipated by economists and market analysts, who had been predicting a rate cut due to slowing economic growth and easing inflation. According to Governor Tiff Macklem, the central bank's confidence in the inflation outlook has increased, with recent data suggesting that inflation is moving closer to the BoC's 2% target.

"With further and more sustained evidence underlying inflation is easing, monetary policy no longer needs to be as restrictive," Macklem stated during the announcement.

Economic Indicators and Market Reactions

The BoC's decision was influenced by several key economic indicators. Economic growth in the first quarter of 2024 was slower than expected, with an annualized rate of 1.7%. Additionally, inflation in Canada has slowed to a three-year low of 2.7% in April, remaining below 3% for four consecutive months. Despite this progress, inflation is still above the BoC's 2% target, necessitating a cautious approach to further rate cuts.

Financial markets reacted swiftly to the announcement, with the Canadian dollar weakening by 0.22% to 1.3708 against the U.S. dollar. Market participants have priced in a 42% chance of another rate cut to 4.50% in the next BoC meeting scheduled for July 24, 2024.

Global Context and Implications

The BoC's rate cut is notable as it diverges from the monetary policies of other major central banks, such as the Federal Reserve, which have maintained higher interest rates to combat persistent inflation. This divergence raises questions about the potential risks and benefits of the BoC's approach. Governor Macklem acknowledged these concerns, stating, "There are limits to how far we can diverge from the United States, but we're not close to those limits".

The BoC's move also aligns with actions taken by other central banks, such as Sweden's Riksbank and the Swiss National Bank, which have also reduced rates in response to easing price pressures and muted economic growth. The European Central Bank is expected to follow suit, according to market forecasts.

Future Outlook

Looking ahead, the BoC has indicated that further rate cuts are possible if inflation continues to ease and economic conditions evolve as expected. However, the central bank emphasized a cautious and data-dependent approach, with decisions being made on a meeting-by-meeting basis. Governor Macklem reiterated that the pace of rate reductions would be slower than the pace of previous rate hikes, ensuring that the BoC remains vigilant against potential risks.

"If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate," Macklem said.

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