The Bank of Canada (BoC) is changing its tune. After a period of aggressive interest rate hikes to combat inflation, the central bank is now signalling a shift towards easing monetary policy. With inflation cooling and the labour market showing signs of softening, the BoC is expected to embark on a series of rate cuts, potentially relieving borrowers across Canada. This blog post delves into the key forecasts, potential impacts, and the economic factors driving the anticipated rate cuts.
Key Takeaways:
- Expected Rate Cuts: Major Canadian banks are forecasting a series of interest rate cuts, with some projecting the BoC policy rate to fall as low as 2.00% by the end of 2025.
- Relief for Borrowers: Variable-rate mortgage and line of credit holders may see reduced monthly payments, easing financial pressures.
- Shift in Focus: The BoC’s priorities shift from inflation control to addressing concerns over a softening labour market and stimulating economic growth.
- Economists Divided: There is no consensus on the timing and magnitude of rate cuts, as experts weigh inflation against economic slack.
Detailed Analysis
The BoC has already begun its rate-cutting cycle. These cuts are significant because they signal a potential turning point in the economic landscape. Lower interest rates stimulate borrowing and investment, potentially leading to broader economic recovery.
Predictions and Potential Impact
Several major financial institutions have released their forecasts for the BoC’s policy rate by the end of 2025:
- RBC and National Bank: Project a rate of 2.00%, the lowest among the forecasts. This could translate to a prime lending rate of about 4.20% at most lenders, offering substantial relief to borrowers with variable-rate loans.
- CIBC: Predicts a 2.25% policy rate, marginally higher than RBC and National Bank’s forecast but still signalling significant easing.
- BMO and TD Bank: Both predict a more conservative policy rate of 2.50%.
- Scotiabank: Expects the BoC’s overnight target rate to fall to 3.00%, indicating the bank may adopt a slower approach to easing monetary policy.
| Metric | Current Policy Rate | Policy Rate: Q4 ’24 | Policy Rate: Q4 ’25 | 5-Year Bond Yield: Q4 ’24 | 5-Year Bond Yield: Q4 ’25 |
| BMO | 4.25% | 3.75% | 2.50% | 2.90% (+30bps) | 2.55% |
| CIBC | 4.25% | 3.50% | 2.25% | N/A | N/A |
| National Bank | 4.25% | 3.25% (-25bps) | 2.00% (-75bps) | 2.65% (+5bps) | 2.05% (-50bps) |
| RBC | 4.25% | 3.25% (-50bps) | 2.00% (-100bps) | 2.75% (-15bps) | 2.20% (-80bps) |
| Scotiabank | 4.25% | 3.50% (-25bps) | 3.00% | 3.00% (+10bps) | 3.75% (+20bps) |
| TD Bank | 4.25% | 3.75% | 2.50% | 3.05% (+15bps) | 2.60% |
Potential Relief for Borrowers
For Canadians with variable-rate loans, particularly those holding mortgages and lines of credit, the forecasted rate cuts could lead to noticeable relief.
- Variable-rate mortgage holders: Their payments are directly impacted by BoC policy rates, so lower rates mean lower monthly payments.
- Line of credit holders: Will also benefit from lower interest charges.
This effect would be particularly beneficial for individuals with high levels of debt, helping ease their financial burden as borrowing costs drop.
How Rate Cuts Impact Fixed-Rate Mortgages
While variable-rate mortgages directly reflect changes in the BoC’s policy rate, the connection is less direct for fixed-rate mortgages. Fixed mortgage rates are primarily influenced by the yields on Government of Canada bonds.
- Bond Yields and Fixed Rates: When bond yields rise, fixed mortgage rates tend to increase, and when bond yields fall, fixed rates generally follow.
- Market Expectations: Even though the BoC has started cutting rates, fixed mortgage rates haven’t dropped significantly yet. This is because financial markets have been anticipating these rate cuts for some time, and those expectations were already factored into bond yields.
- Lagging Effect: There can be a lag between BoC rate cuts and their impact on fixed mortgage rates. As the bond market fully absorbs the BoC’s actions and adjusts its expectations for future rate cuts, we may see a more pronounced decline in fixed rates.
Why haven’t fixed rates dropped significantly yet?
- Inflation Concerns: While inflation has cooled, it remains a concern. If markets believe the BoC might need to reverse course and raise rates again if inflation rebounds, bond yields may not fall significantly, keeping fixed rates relatively stable.
- Economic Uncertainty: Global economic conditions and uncertainty about the Canadian economy’s future can also influence bond yields and, consequently, fixed mortgage rates.
Fixed-rate mortgages are less directly impacted by BoC rate cuts than variable-rate mortgages. Changes in fixed rates depend on how bond yields react to the BoC’s policy changes and broader economic conditions. While fixed rates may not have fallen significantly yet, continued rate cuts by the BoC could eventually lead to lower fixed rates as bond yields adjust.
Reasons for the Rate Cuts
Several economic factors are driving the expected rate cuts:
- Cooling Inflation: Canada’s inflation rate has dropped significantly, falling below the BoC’s 2% target. This provides the BoC with more room to maneuver and shift its focus to supporting economic growth.
- Falling prices in key sectors like food and housing are contributing to this decline.
- Weakening Job Market: Despite some recent job creation, there are signs of underlying weakness in the labour market.
- Rising unemployment is a concern, with economists forecasting it could reach 7% by early 2025.
- Lower borrowing costs can stimulate demand and encourage businesses to hire, helping to prevent further job market deterioration.
- Economic Slack: The gap between the economy’s current output and its full potential has widened.
- Reduced consumer spending and lower business investment signal easing demand-side pressures.
- Rate cuts can encourage spending and investment, countering this trend and stimulating economic activity.
Expert Opinions on the Rate Cuts
While there is a consensus that rate cuts are coming, economists differ on the timing and magnitude:
- Scotiabank: Predicts a cautious approach with a 50-bps cut followed by smaller, gradual reductions.
- RBC Economics: Advocates for a quick return to a neutral rate, emphasizing the importance of a balanced policy for sustainable growth.
- CD Howe Institute: Suggests the BoC might need to be even more aggressive, potentially setting rates below the neutral level to stimulate demand.
- BMO: Expects a significant initial cut but cautions against expecting similarly large cuts in the following months.
- Desjardins: Forecasts a series of cuts throughout 2025, with an initial larger cut followed by smaller reductions.
- Oxford Economics: Predicts a more aggressive approach with back-to-back significant cuts.
- National Bank: Emphasizes the data-dependent nature of future cuts, highlighting that the BoC will closely monitor economic conditions.
Monitoring the Economic Impact of Rate Cuts
The Bank of Canada is facing a complex economic landscape. While lower inflation provides some breathing room, concerns remain about the labour market and overall economic growth. Rate cuts can provide relief to borrowers, but the BoC must carefully calibrate its policy to avoid reigniting inflation. For Canadian borrowers, staying informed about rate changes is crucial. Lower borrowing costs can offer some financial breathing room, but proactive financial planning remains essential in these uncertain times.
