Bank of Canada slashes rates, says monetary policy has worked

By Promit Mukherjee and David Ljunggren

OTTAWA (Reuters) -The Bank of Canada on Wednesday reduced its key benchmark rate by 50 basis points to 3.75%, its first bigger-than-usual move in more than four years, and hailed signs the country has returned to an era of low inflation.

The central bank, which hiked rates to a 20-year high to fight soaring prices, has now cut four times in a row since June. Inflation in September sank to 1.6%, below the 2% target.

"Canadians can breathe a sigh of relief. It's a good news story," Governor Tiff Macklem said during a press conference after the rate announcement. "It's been a long fight against inflation, but it's worked, and we're coming out the other side."

Despite three previous cuts totaling 75 basis points, demand has been muted, sales at businesses are sluggish and consumer sentiment is tepid, hurting economic growth.

"Today's interest rate decision should contribute to a pickup in demand," Macklem said, adding that the BoC would like to see growth strengthen.

The U.S. Federal Reserve last month started its own rate reduction cycle with a similar size move.

Economists and analysts now see a possibility of another jumbo cut building up in December.

"Based on the logic offered to justify today's decision, it would take a significant turn of events to stand in the way of another cut of that magnitude in December," CIBC Chief Economist Avery Shenfeld wrote in a note.

The last time the Bank of Canada cut rates by 50 basis points at a scheduled meeting was in March 2020.

The headline September inflation rate of 1.6% underscored concerns the high cost of borrowing might have suppressed the rise in prices more than the economy needed.

"Now our focus is to maintain low, stable inflation. We need to stick the landing," Macklem said.

Money markets are fully pricing in a 25-basis-point cut in the final monetary policy decision announcement of the year on Dec. 11. They are seeing an over 25% chance of another 50-basis-point cut.

The Canadian dollar was down 0.15% at 1.3839 to the U.S. dollar, or 72.26 U.S. cents. Yields on Canada's two-year government bond eased 2.1 basis points to 3.013% after the rate cut announcement.

"Another 50 (basis points) in December is not a slam dunk. It will depend on where the BoC thinks neutral is," said Kyle Chapman, forex markets analyst at Ballinger Group.

The central bank said it sees the neutral rate - where the monetary policy is not considered to be restricting growth but also accelerating growth - between 2.25% and 3.25%.

Macklem reiterated that if the economy continues to evolve broadly in line with forecasts, the bank would cut rates again, with the timing and pace depending on the latest data.

Canada's economic growth has sputtered under the impact of high rates. July GDP grew by just 0.2% on a monthly basis and provisional data suggest August growth will likely stall.

The bank revised its forecast for quarterly and annual growth in its latest monetary policy report (MPR) released along with the rates announcement on Wednesday.

It now expects annualized GDP growth in the third quarter to be 1.5%, down from the 2.8% it predicted in July, but kept its full year forecast unchanged at 1.2%.

The overall annual inflation rate this year is seen at 2.5%, falling to 2.2% in 2025 and 2.0% in 2026, the MPR showed.

The bank, however, is still concerned about inflation coming in higher or lower than expected going forward. "The economy functions well when inflation is around 2%," Macklem said.

(Reporting by Promit Mukherjee and David Ljunggren; Editing by Mark Porter)