Photo by Michelle Spollen on Unsplash

The Bank of Canada lowered its overnight rate from 5% to 4.75% today, a move that was widely expected. The Bank no longer feels it is necessary adopt a restrictive monetary policy, as recent inflation data is heading in the right direction in meeting its 2 % target. So, when the rate of inflation continued its slow journey towards the target, the Bank had to acknowledge that inflation was now under control and rates need to go into reverse.

However, the Canadian economy has clearly fallen well below trend.  Over the past four decades, real GDP per capita has expanded by an annual average rate of 1.1 %, until COVID-19 struck in 2021. The shock of the pandemic plus the weak performance in subsequent quarters left the economy 7% below the trend line.

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In 2023 Canada’s population grew by 3.2%, well in excess of GDP expansion of 1.1 %. We can anticipate that this weakness continues throughout 2024. So far, annualized growth for 2024Q1 came in at 1.7%, below the expected increase in population. This further deterioration in per capita income growth calls into question why the economy continues to falter. Canadian business investment continues to underperform, the external trade sector is far from robust and consumers continues to be weighed down by debt. The Bank freely admits that the economy operates with excess capacity. Put differently, the economy can absorb further economic expansion without contributing to inflation.  

Enter the Bank of Canada with its first rate cut in four years. Helpful as this cut will be, it is subject to long lags before its impact will be felt . The Bank needs to be prepared to offer a series of rate cuts if it hopes to see a turnaround in economic performance.

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