The Bank of Canada cut interest rates by 25 basis points for the second time in a row and signaled that further cuts are likely if inflation continues to cool as expected.

Led by Bank of Canada Governor Macklem, policymakers cut their benchmark overnight interest rate to 4.5% on Wednesday, in line with market expectations. Officials argued that below-potential growth will continue to hold back inflation and said they were spending more time discussing economic headwinds.

“With inflation within sight and excess supply in the economy building, downside risks weigh more heavily on our monetary policy deliberations,” Macklem said in his prepared remarks.

After the resolution was announced, the USD/CAD exchange rate rose nearly 30 points in the short term, short-term bonds rose, and Canada's two-year benchmark yield was pushed up to 3.629%.

Macklem reiterated that it was "reasonable" to expect further rate cuts and that the central bank would make those decisions "meeting by meeting," dismissing expectations that the Bank of Canada was on a predetermined path to cut rates.

Officials said they continued to make progress in curbing price pressures and that a return to the 2% inflation target was "within reach." The Bank of Canada said June CPI data showed that the year-on-year pace of inflation slowed to 2.7%, suggesting that price pressures were easing.

Overall, officials appeared more confident that price pressures were under control and increasingly focused on ensuring the economy had a soft landing. The series of dovish comments suggests the Bank of Canada has turned its attention to ensuring inflation does not fall sharply below its 2% target.

It marks a significant shift in the Bank of Canada’s attitude toward inflation. Officials said in a summary of discussions at their June meeting that they had debated whether they needed more evidence before continuing to ease policy. Now they are more confident.

The balance of risks is also shifting. Officials cited weaker-than-expected household spending as the main downside risk and pointed to upcoming mortgage renewals as a risk to consumption growth. The Bank of Canada said in its statement that it was seeing "further signs of slack" in the labor market and said it was taking longer for job seekers to find work.

In June, the Bank of Canada became the first G7 central bank to cut interest rates. Since then, the European Central Bank has also begun to ease monetary policy. Importantly, markets and economists are increasingly confident that the Federal Reserve will also start cutting interest rates.

In its monetary policy report, the Bank of Canada left its economic forecasts broadly unchanged -- it expects growth to remain in excess supply over the forecast period. Inflation is expected to rise 2.6% this year and decelerate steadily to 2% by the end of 2025. A sharp rise in house prices is no longer listed as a major upside risk, and officials lowered housing's contribution to the economy in 2024.

In an accompanying report, the Bank of Canada forecast growth would accelerate to 2.8% in the third quarter, partly due to increased exports following the expansion of the Trans Mountain pipeline, and forecast growth of 1.2% in 2024, down from a previous forecast of 1.5%.

The Bank of Canada said wage growth, while rising, is slowing as the labor market eases, business pricing behavior is "largely normalizing" and inflation expectations are falling.

In June, the final paragraph of the Bank of Canada’s policy statement focused on those concerns, but July’s statement was largely rewritten to focus on “persistent excess supply” and “opposing forces” in inflation, with the central bank seeing housing and services prices as holding back inflation progress.

The statement made no mention of the recent reacceleration of the three-month moving average of the Bank of Canada’s preferred core inflation measure, which accelerated to 2.91% in June. Instead, policymakers highlighted progress in the median and revised annual changes in the CPI, which are expected to slow to 2.5% under the newly added forecasts.

Moving faster would allow policymakers to get ahead of upcoming mortgage renewals, reducing the payment shock for buyers who signed on at low rates during the coronavirus pandemic, but cutting rates too quickly could reignite the country’s tight housing market.

Article forwarded from: Jinshi Data