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Canada becomes first G7 nation to cut interest rates

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By Promit Mukherjee and David Ljunggren

OTTAWA (Reuters) – The Bank of Canada trimmed its key policy rate on Wednesday, the first G7 country to do so, in a widely expected move that will ease pressure on highly indebted consumers, but indicated further easing would be gradual and dependent on data.

“Let’s just enjoy the moment for a bit,” said Governor Tiff Macklem at a press conference after announcing the central bank had reduced rates to 4.75% from 5%, the first cut in four years.

Macklem stressed the timing of the next cut would depend on whether inflation continued its downward trajectory and the economy evolved in line with the bank’s expectations.

Some economists predicted the BoC would cut again in July even though financial markets had priced in a 39% chance of a cut to 4.50% next month.

A majority of economists polled by Reuters had expected Wednesday’s easing.

U.S. inflation is stickier and markets expect the Federal Reserve will cut rates only once this year. Economists have questioned whether the BoC is running the risk of diverging too much from the Fed.

“There are limits to how far we can diverge from the United States, but we’re not close to those limits,” Macklem said.

Following the decision, the Canadian dollar pared its early gains and weakened by 0.22% to 1.3708 to the U.S. dollar, or 72.98 U.S. cents.

The BoC joins Sweden’s Riksbank and the Swiss National Bank in bringing down rates that have burdened households and businesses alike, amid muted economic growth despite easing price pressures.

The European Central Bank is most likely to follow suit on Thursday, according to a Reuters poll.

Inflation in Canada has slowed this year to hit a three-year low of 2.7% in April. While inflation has stayed below 3% for four months in a row, it is still higher than the Bank’s 2% target.

“If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate,” Macklem said in an indication of what future reductions could look like.

“But we are taking our interest rate decisions one meeting at a time,” he added.

“We have increasing confidence that the Bank of Canada will move again in July,” Royce Mendes, head of macro strategy for Desjardins Group, wrote in a note.

Andrew Grantham, senior economist at CIBC, also said he expected a cut in July, adding that he foresees a total of four reductions this year.

The next rate announcement is due on July 24, when the bank will also release its latest quarterly forecasts.

RUNWAY IN SIGHT

After keeping interest rates at a more than two-decade high of 5% for almost a year, the BoC said the indicators for underlying inflation looked increasingly positive.

The bank had increased interest rates by 475 basis points in a space of 16 months until July 2023 and since then had kept it steady at 5%.

Macklem said rates would fall at a slower pace than they had risen and said rates would settle at a level higher than they had been before the COVID-19 pandemic.

Economic growth in the first quarter was slower than expected at an annualized rate of 1.7%, helping boost market anticipation of a rate cut.

Macklem said the economy was operating in excess supply – essentially meaning the amount of goods produced exceeds demand – leaving room for growth even as the overall inflation rate continues to drop.

When asked whether the economy could be in for soft landing, he said: “The runway is in sight, but we still need to land this.”

He reiterated that the bank would remain focused on a mismatch between demand and supply, inflation expectations, wage growth and corporate pricing behavior.

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