Economists call for more aggressive rate cuts as inflation hits Bank of Canada’s 2% target

Canada’s annual rate of inflation fell to two per cent in August, its lowest rate in more than three years, and spot-on the Bank of Canada’s official target.
The biggest question? Whether the drop is significant enough to push the Bank into a half-percentage-point rate cut at its next meeting in October.
The annual rate of inflation — as measured by the Consumer Price Index — fell to two per cent last month, down from 2.5 per cent in July, Statistics Canada announced Tuesday.
In a research note after the numbers were released, TD senior economist James Orlando called it a “bullseye.”
“Bullseye! Headline inflation is back at the Bank of Canada’s two per cent target. At the same time, core measures keep grinding lower,” Orlando wrote.
“The bottom line … is that inflation remains unthreatening and the Bank of Canada should now focus on trying to stimulate the economy and halting the upward climb in the unemployment rate,” CIBC economist Andrew Grantham wrote in a research note after the results were released.
Grantham noted that while gasoline prices were a big reason for the drop in inflation, there were plenty of other areas as well, including clothing and footwear, which saw prices fall from July.
That, Grantham and Statistics Canada noted, was especially unusual for a category that usually jumps up in August because of demand from back-to-school shoppers.
“It was the first August decline in that component since 1971, and could be an indication that weak demand had left retailers with a stock overhang toward the end of the summer,” Grantham wrote.
The plunge in inflation makes it more clear that the Bank needs to start cutting its rates even more quickly than it already has, argued National Bank economists Matthieu Arseneau and Kyle Dahms. At 4.25 per cent, the Bank’s key overnight lending rate is still high enough it risks harming the economy and pushing unemployment higher, Arseneau and Dahms suggested.
“With widespread inflation a thing of the past in Canada, we believe the door is wide open for the Bank of Canada to move its policy rate back to neutral (between 2.5 and three per cent) as quickly as possible by making larger rate cuts than it has in the past,” Arseneau and Dahms wrote.
The Bank of Canada has now cut its key overnight lending rate 25 basis points — a quarter of a percentage point — three meetings in a row.
The bank raised rates 10 times between March 2022 and last summer in a bid to wrestle inflation down to its two per cent target. Inflation peaked at 8.1 per cent in June 2022, as the Canadian economy opened back up from COVID-related restrictions.
The theory is that by making it more expensive to borrow money, consumers and businesses will spend less, driving down prices and slowing the economy.
Now, as the economy slows and inflation has been heading (mostly) downward, the bank is taking the reverse approach, trying to stimulate growth by cutting interest rates.
Trading on the overnight interest swap market has priced in a 50 per cent chance of a 50-basis-point cut at the Bank’s next rate decision Oct. 23, while a 25-point cut is already fully priced in.
TD’s Orlando argued that the Bank needs to keep cutting to keep the economy from slumping further.
“Inflation continues to validate the need for the Bank of Canada to continue cutting its policy rate. We calculate that the current policy rate is still nearly 200 basis points above where it should be based on the current state of the economy,” Orlando wrote.
Given how many sectors saw inflation fall in August, there’s no doubt Tuesday’s numbers might have tipped the balance — at least a bit — toward a 50-point cut, said BMO’s Benjamin Reitzes.
“The question markets are grappling with is whether the next move will be 25 bps or 50 bps. … Today’s figure tilts the scales a touch toward a more aggressive path,” Reitzes wrote.