Interest rate cuts unlikely to immediately spur Canadian economic growth

Analysts warn against high expectations over rate cuts

Interest rate cuts unlikely to immediately spur Canadian economic growth

According to the Royal Bank of Canada (RBC), while the Bank of Canada (BoC) is anticipated to implement four interest rate cuts this year, these adjustments are not expected to immediately boost the Canadian economy. RBC’s analysis suggests that the economic benefits of these rate cuts will likely be limited, indicating that they are “more akin to easing off the monetary policy brakes [rather] than stepping on the gas.”

RBC’s senior vice president and chief economist, Craig Wright, highlighted that despite global economic growth showing signs of improvement, Canada continues to underperform. On a GDP-per-capita basis, Canada’s economy remains 3% below 2019 levels, in stark contrast to the US, where per capita GDP has increased by 7% during the same period. This 10% swing underscores the challenges facing the Canadian economy.

Impact of interest rate cuts

According to the Financial Post, the BoC decided to cut its benchmark lending rate by 25 basis points to 4.75% due to a weakening economy, excess supply, and slowing inflation. Wright noted that while households may welcome the cuts, past rate hikes will still elevate debt payments, limiting relief. RBC projects GDP growth of 1% in 2024, improving slightly to 1.8% in 2025.

RBC predicts that additional rate cuts totaling 75 basis points this year will still leave the BoC’s rate above the neutral range of 2.25% to 3.25%, which is neither stimulative nor restrictive for economic growth. The bank foresees that economic growth will continue to be subdued, with rate cuts having a limited positive impact in the short term.

Wright noted that higher rates will impact $200 billion in mortgages this year and $275 billion in 2025. Despite the payment shock, rising incomes should help manage it. However, rate cuts won’t significantly improve housing affordability due to a structural accommodation shortage or address declining productivity.

Growth forecast

RBC’s GDP forecast shows slower growth for Ontario, Quebec, and British Columbia due to high household debt, while the Prairie provinces, particularly Alberta, are expected to see stronger growth of 1.7%, driven by resilient spending and a slight rise in oil prices.

Statistics Canada reported a slight decrease in household debt relative to income in the first quarter of 2024. The debt-to-income ratio fell to 176.4% from 178.0% in the previous quarter, with a marginal drop in the debt-service ratio as disposable income rose faster than debt payments.

While the BoC’s interest rate cuts are a step towards easing monetary policy, RBC’s analysis suggested that the Canadian economy will remain sluggish, with significant challenges ahead. The anticipated economic growth from these cuts will likely be modest, underscoring the need for a broader strategy to address the underlying issues in the economy.