Canada’s Rate-Cutting Cycle has Begun: How Low will Rates Go?

As we expected, Canada cut its benchmark interest rate by 25 basis points to 4.75% on June 5. Earlier this week, Bank of Canada Governor Tiff Macklem spoke publicly for the first time since that decision.

Wearing a bright orange tie to support the Oilers ahead of game seven, Macklem told Winnipeg’s Chamber of Commerce that Canada faces slack in its labour force while productivity shortcomings are becoming an emergency.

Macklem reminded the audience that “price stability is the number one priority” for the central bank, and he reiterated its 1-3% inflation band (with 2% being the target).

Slack in the Labour Force

Lately, businesses have slowed hiring, making it more difficult for fresh graduates and new immigrants to find a job. That gives the Bank of Canada comfort that our economy can tolerate some growth from today’s levels without inflation simultaneously accelerating.

Productivity Crisis

Productivity is simply an economist’s word for output per worker. According to Macklem and his colleagues, the productivity decay is reaching “emergency levels”. In the 1970s, Canada and the U.S. were equally as productive. Today, we’re about 70% as productive as the U.S.. Some have called this decline “without precedent in the post-war era.” Macklem believes there are three components to improving productivity.

1. Ensure there are strong “framework policies” such as low inflation, free trade agreements, and a competitive tax regime are needed.
2. Reduce regulatory nuances between provinces that create unnecessary burdens on businesses.
3. Accelerate the regulatory approval process.

The themes from Macklem’s speech on Tuesday provide further justification to cut Canada’s benchmark rate.

If one needs another reason, look no further than the mortgage renewals that will take place in the next couple of years. Almost 60% of all outstanding Canadian mortgages will renew in 2024, 2025, and 2026. The higher renewal rate will gobble up more cash flow from each borrower’s monthly paycheque, leaving less money to spend on other goods and services.

For these many reasons, we expect Canada to cut rates further and faster than the U.S. Our expectation is for another cut at the July 24 meeting (with more to follow before the end of the year). We believe the benchmark rate will settle around 3.25 to 3.5%, a 125 to 150 basis point reduction from today’s 4.75%. We expect dividend-paying stocks to benefit most from these rate cuts as GIC investors look to replace their lost income.