Will interest rates come down in 2024? What the Bank of Canada is watching

After the Bank of Canada held its benchmark interest rate steady in its final three decisions of 2023, the tone of conversations in markets has shifted firmly away from further rate hikes and staunchly into the camp of when cuts could begin.

Even Tiff Macklem, the Bank of Canada’s top policymaker, has begun to acknowledge as of late that rate cuts could be in the cards for the new year, despite ongoing warnings that the central bank is prepared to raise rates again if progress taming inflation stalls.

The Bank of Canada’s rapid run-up in the policy rate — it currently sits at 5.0 per cent, up 4.75 percentage points since March 2022 — has put immense pressure on Canadian households, businesses and governments by ratcheting up the cost of borrowing in an effort to tamp down price pressures.

Many Canadians, particularly homeowners who are set to renew their mortgages and are bracing for higher payments in the coming years, are eagerly watching for signs that the tightening cycle could be coming to an end.

Economists who spoke to Global News say they are indeed forecasting a decline in the policy rate for 2024.

But they, like Macklem and his peers, hold the hint of caution in their forecasts. Experts say that inflation’s path back down to the central bank’s two per cent target may well be a bumpy one, which could well delay the timeline for interest rate cuts next year.

In a year-end speech at the Canadian Club in Toronto earlier this month, Macklem hailed the “significant progress” in cooling inflation to-date.

“We’ve come a long way toward restoring price stability,” Macklem said in his speech. “This was our second year of monetary policy tightening, and that work is paying off. The economy is no longer overheated, and that is relieving inflationary pressures.”

The annual inflation rate stands at 3.1 per cent as of November, according to Statistics Canada, a full five percentage points lower than the 41-year-high seen in June 2022.

Many economists expected inflation to dip below three per cent in November, only to be surprised to the upside with sticky price pressures at the grocery store, as well as on shelter and some services.

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Those figures were released after Macklem’s speech in Toronto, but the central bank governor said a day later in an interview with BNN Bloomberg that the Bank of Canada’s projections have interest rates coming down “sometime” in 2024. He reiterated in that interview that the Bank of Canada is looking for months of sustained progress in core inflation metrics before it’ll commit to cutting rates.

Macklem’s counterpart south of the border, Jerome Powell, has been more plain in his language as of late. In announcing its December rate hold, the U.S. Federal Reserve said it expects three rate cuts in 2024.

Many Bay Street economists reiterated their expectations for rate cuts following the November inflation data. Some are calling for rates to fall come June, while money markets have cuts starting as early as April.

Derek Holt, vice-president and head of Capital Markets Economics at Scotiabank, is not convinced.

“Sorry but I just can’t hop on the bandwagon,” he wrote in a note to clients on the day of the November inflation report. He argued that month-to-month pickups in the Bank of Canada’s core inflation metrics point more towards the risk of another hike rather than a pivot to cuts.

Speaking to Global News before that data report, Holt said that he expects the Bank of Canada will “struggle” when it comes to getting inflation all the way back to the two per cent target.

One of the areas where Holt and the Bank of Canada agree is the risk that the spring housing market reignites inflation.

The meeting minutes for the Bank of Canada’s Dec. 6 rate hold decision show the governing council worried that easing monetary policy “prematurely” would spur a “rebound” in housing activity, as lower interest rates bring prospective homebuyers back into the market.

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But even without the central bank cutting rates, some borrowing costs are already dropping heading into the new year.

Five-year fixed rates on insured mortgages dipped below five per cent in December, the first time that happened since May, according to comparison site Rates.ca. Weakness in the bond market since October has driven down some of the bond yields that lenders use as a benchmark on mortgage products as market watchers anticipate rate cuts in the new year.

Holt thinks it’s wise for the Bank of Canada to keep its tightening bias heading into the new year. Clearly signalling an end to hikes would only stoke more bets in the bond market that rates are set to fall heading into the traditionally busy spring housing market, he says.

Relief on mortgage rates, at a time when housing supply is constrained and demand is buoyed after a year of strong job gains and record population growth, could make for a red-hot spring market, Holt argues.

“I think the last thing you want to do is to be in a rush to cut interest rates, inflame housing markets, and light up inflation risk all over again,” he says.

Other experts who spoke to Global News recently expect a slow start to the housing market in 2024, with prices and sales activity picking up in the second half of the year following a cut to the Bank of Canada’s policy rate.

But real estate is not the only potential hiccup in the inflation outlook.

Pedro Antunes, chief economist at the Conference Board of Canada, tells Global News that fears of escalation in the Middle East over the conflict between Israel and Hamas could well have knock-on effects for supply chains and inflation globally, like the Russian war in Ukraine before it.

“The last thing the world needs right now is another ramp up, another oil price shock, another layer added to inflationary pressures that are still working themselves out of the system,” he says. “There’s always risks to our economic forecast. This one is one that is particularly on the radar right now.”

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Elsewhere on the global stage, Holt’s eyes are locked on the upcoming 2024 election in the United States.

A second Donald Trump presidency would present the Bank of Canada with a “very difficult set of circumstances,” he argues.

Trump’s use of tariffs in his first term could set up more geopolitical risks to trade and supply chains in a hypothetical second, Holt says. If those risks materialize, the Bank of Canada could be faced with weaker growth than currently forecasted and “persistent inflationary pressure.”

Wage growth in the range of four to five per cent remains “absurdly hot” in relation to inflation, Holt said in his recent note. The Bank of Canada has also flagged these pay gains, alongside outright declines in productivity over recent quarters, as inconsistent with bringing inflation back down to target.

Canada’s labour market has continued to add jobs through 2023, despite a rise in the unemployment rate thanks to a growing workforce. But there are signs of cooling in the data, and economists say the trajectory of Canada’s overall economy holds a great deal of sway for the central bank’s rate path.

Both Holt and Antunes have the Canadian economy avoiding an outright recession in their forecasts. Some forecasters are still pencilling in a short, shallow recession for late 2023 or early 2024, but few are expecting steep job losses like more severe downturns of the past.

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Antunes notes that if growth takes a more significant hit in the new year, a wave of layoffs and bankruptcy could force the Bank of Canada off its hold position even more rapidly than forecasters currently project.

“If we do start to see the economy unravel a bit more quickly than we expect …the good news is that there’s room to maneuver here, for the Bank of Canada to take rates down quicker,” he says.

In his year-end speech, Macklem told Canadians that 2024 is likely to be a “year of transition.” He warned the coming quarters will be “difficult for many” as growth slows and consumers are forced to rein in their spending.

But he also offered optimism that the conditions the Bank of Canada is looking for to achieve its two per cent inflation goal “increasingly appear to be in place.”

Macklem predicted that when he delivers his year-end speech in 2024, the economy will be growing again and inflation will still be trending back towards two per cent. The Bank of Canada’s latest forecasts have annual inflation hitting that target sometime in mid-2025.

“Of course, predicting the future is difficult. It could be harder than we think to get inflation down,” Macklem said in his speech. “We know that we will need to remain vigilant.”

— with files from Global News’ Anne Gaviola