Q2 2024 Macroeconomic snapshot: Interest rate cuts are not necessarily a death sentence for the loonie

The Bank of Canada (BoC) lowered its overnight interest rate in June to 4.75%, the first of several cuts expected to be delivered over the next twelve months. While lower rates do not bode well for the Canadian dollar, that’s not to say the loonie is doomed. The U.S. Federal Reserve (Fed) is also poised to cut rates later this year, bringing an extended period of US dollar strength to an end.

Why is now the time for cuts to begin?
While the BoC analyzes many data points when setting the course for monetary policy, one of the more important pieces of data is core inflation. Core inflation strips out the more volatile components of the consumer price index to give a broader sense of underlying price pressures in the economy. There are a multitude of ways to calculate core inflation, but today we look at the all-items excluding food and energy from the last three months (calculated at an annualized rate). Looking at the last three months’ data gives us a better understanding of recent trends compared to a year-over-year calculation of inflation.

There was concern in the latter half of 2023 that inflation was ‘sticky’ (Figure 1). From August to December 2023, this measure of core inflation hovered above 3.0%. While this was down from the peak in 2022, it was still too high for the BoC and, more importantly, stopped trending downward and instead trended sideways. However, in the last three months, this rate has been below 2.0%. In fact, it’s at the lowest level since the spring of 2021. As well, other measures of core inflation are showing similar improvement.

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