Why Did Canada Cut Interest Rates Before the US?

North of the border, interest rates are going south.

The Bank of Canada became the first major central bank to approve a rate cut Wednesday, marking a turning point in the international fight against inflation following its post-pandemic surge. The Canadian central bank cut its interest rate a quarter-point to 4.75%, its first reduction in four years. That makes Canada the first member of the Group of Seven (G7) economies to lower borrowing costs.

So why is Canada cutting rates before the U.S. and other countries?  In short, Canada’s central bank is more confident than its U.S. counterpart that it is winning the war on inflation. 

“Total consumer price index (CPI) inflation has declined consistently over the course of this year, and indicators of underlying inflation increasingly point to a sustained easing,” said Bank of Canada Governor Tiff Macklem, the Canadian counterpart to Fed Chair Jerome Powell.

Canada Sees Inflation Improvement, While US ‘In Different Place’

Like the U.S., Canada has a 2% target for inflation, and also like its southern neighbor, price increases there have slowed since peaking in mid-2022, with Canadian CPI falling to 2.7% in April.

That’s not much different than the 2.7% inflation measured by the U.S. Personal Consumption Expenditures (PCE), which the Federal Reserve uses to track price changes. However, Canada’s inflation has steadily declined since the beginning of the year. Meanwhile, in the U.S., inflation was stoked in the first quarter.

At an event last week, New York Fed President John C. Williams acknowledged the different experiences of Europe, Canada, and other countries that were ready to cut rates. 

“We’re in a slightly different place right now,” Williams said.

He didn’t speculate on when the Federal Reserve would cut rates, only noted officials needed more evidence that price pressures in the U.S. were cooling. 

Canada’s Interest Rate Path Uncertain

While the Bank of Canada may have been the first to cut rates, there’s little certainty about when the next cut will come.

“This is indeed likely to be the first of a series of cuts, although that series is not going to be a straight line down by any means. The Bank’s tone is a bit more dovish than expected, but each and every cut this year will require evidence that inflation is calming,” said Douglas Porter, chief economist at BMO Economics.

At his press conference Wednesday, Macklem said Canada was in a position to cut rates, but couldn’t get too far ahead of the U.S., which has held its interest rate at a decades-high level of 5.25% to 5.5% for almost a year. 

“There are limits to how far we can diverge from the U.S. and we are not close to those limits,” Macklem said.

The European Central Bank is also expected to cut its rate for the first time this cycle when it meets on Thursday. Investors and market watchers in the U.S. don’t anticipate the Federal Reserve cutting interest rates until September, according to data analyzed by the CME FedWatch Tool.