Does the Interest Rate cut in Canada provide realistic hope Australia will follow suit?

Ujjwal Maheshwari Ujjwal Maheshwari, June 12, 2024

Why would the Interest Rate cut in Canada be of any relevance to investors in any other country, including in Australia? Because it may provide hope that Australia may not be too far off. And of course, if rates are cut in Australia, it may mean your mortgage or rent will go down, but it could also impact your investment portfolio.

 

The first interest rate cut in Canada since 2020

Last week, the Bank of Canada cut interest rates for the first time in over four years – specifically by 25 basis points to 4.75%. And it was the first major central bank among the so-called ‘G7′ countries to do so.

The bank’s governor declared,’ Let’s just enjoy this moment for a bit’. Yes, Tiff Macklem did say that. Granted, it was in the context of reporters asking if there would be another cut next month, although it is rare to see bankers acknowledging the decision would provide such relief as explicitly as he did.

At the same time he said,’ 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’.

 

Why this matters

As is the case in all economic times, interest rates are a powerful tool in the hands of central banks. They influence borrowing costs, consumer spending, business investment, and ultimately, the stock market. But in the current context, it provides hope that other nations will follow suit, including our RBA. And of course, everything else that will follow suit.

Canada’s benchmark stock index rallied 0.8% on the day of the announcement. Tech stocks and gold stocks rose even more, with the S&P/TSX Capped Information Technology Index rising by 1.8% and the S&P/TSX Global Gold Index rising by 1.7%.

This positive movement was driven by investor optimism about the potential for lower borrowing costs to stimulate economic growth and corporate profitability. Mortgagees will see a cut in their repayments and this (along with the Stage 3 tax cuts), will mean more money pumped into the economy. It may mean inflation will rise again, aiding the cause of gold, as well as for investing in tech stocks.

 

Why the Rate Cut?

As good as interest rate cuts will be, the unfortunate reality is that other jurisdictions will not follow suit just because Canada did so. All central banks must consider their own economic conditions. The Bank of Canada’s decision to lower interest rates was influenced by several factors unique to Canada.

Most pertinently, there was clear evidence that inflation was easing. The annual inflation rate declined to 2.7% in April 2024, down from its 8.1% peak in mid-2022. The central bank’s preferred measures of core inflation also showed a sustained downward trend, indicating that inflation would continue to move towards the bank’s 2% target.

Furthermore, the Canadian economy showed signs of slowing growth, particularly in the first quarter of 2024. Weaker inventory investment had impacted overall economic activity, prompting the Bank of Canada to take a more accommodative stance to support growth. The labour market, while still expanding, had not kept pace with the growth of the working-age population, further justifying the rate cut.

 

How can we navigate the Rate Cut Environment?

The Bank of Canada’s decision to lower interest rates marks a significant shift in monetary policy, with broad implications for the stock market and the economy. The rate cut is expected to stimulate growth and support various sectors in Canada, and provide hope cuts are not far off in the USA and Australia, and have a similar impact.

Still, investors must remain vigilant. While recognising that the next movement in interest rates by our RBA (as well as by the Federal Reserve) is more likely to be down than up, it may be several more months before this eventuates, given inflation has been more difficult to tame in Australia and America compared to Canada.

 

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