Canada Slashes Interest Rates, Europe Likely to Follow Suit

Canada’s economy has been kept in check due to higher levels of household debt and shorter-term mortgages in Canada compared to the US.

Image Credit: iStock Images, Gabriel Shakour

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It’s not a race. But if it were, Canada would be winning. And Europe wouldn’t be far behind. Bringing up the rear, of course, is the “higher-for-longer” US. The Bank of Canada lowered its own main interest rate by a quarter percentage point on Wednesday, making it the first nation in the Group of Seven to slash rates in the inflation era. Indications are that the European Central Bank will follow suit on Thursday, too.

Central (Bank) Planning

Canada’s cut isn’t exactly surprising. Last month, Bank of Canada Governor Tiff Macklem signaled the move was coming, and last week, 11 out of 15 economists surveyed by The Wall Street Journal predicted the slash would come on Wednesday. After its core inflation rate peaked at 8.1% in June 2022 (coinciding with the US’s peak of 9.1% the same month), it steadily declined, falling to 2.7% this past April. But unlike the US — which has only recently seen some cooling to a rollicking economy — Canada’s economy has been operating at a low purr for months. That may be due to higher levels of household debt and shorter-term mortgages in Canada compared to the US, both of which mean elevated interest rates pack a little more punch for the average citizen.

The proof is in the numbers. In this year’s first quarter, Canada’s GDP rose just 1.7%, more than a full percentage point below most economists’ expectations. Meanwhile, the unemployment rate is at its highest point in 27 months while job openings are at their lowest since 2021. The EU, too, has seen its inflation rate shrink closer to its target goal and its economy slip into a small lull. For both Canada and the EU, that means it’s finally time to cut rates from historic highs in the hope of securing the elusive soft landing — though what happens next could look different for each central bank:

  • The Canadian Imperial Bank expects three more cuts to come this year, with another one likely as soon as July. “While the language remains cautious, it does not dismiss the possibility that the BoC could cut again in July,” Alberta Central chief economist Charles St-Arnaud told Bloomberg.
  • The ECB, meanwhile, is expected to be more cautious, with most markets ruling out another cut in July and most economists expecting just one cut per quarter through the rest of the year.

Diverting Paths: But one cut per quarter is still faster than the single rate cut most economists expect the Fed to make this year, likely in September. That puts Canada, the EU, and the US on diverging paths — a dynamic that could weaken both the euro and the Canadian loonie, which could mean higher import costs and higher inflation for both regions. In other words, while the US is a step behind in the rate-cut race, it could drag down Canada and the EU in the near future, too.