On September 4, the Bank of Canada made a significant announcement, marking its third consecutive interest rate cut of 25 basis points, bringing the policy rate down to 4.25%. This decision underscores the central bank's continued trend toward monetary easing in response to economic conditionsAlthough inflationary pressures are beginning to moderate, Bank Governor Tiff Macklem warned that inflation could rise again in the future, particularly as base effects fadeNevertheless, Macklem highlighted the likelihood of further interest rate cuts if inflation continues to decline as expected, with the aim of supporting economic recovery.

So, what are the reasons behind the Bank of Canada's decision to continue cutting interest rates? Since June 2023, the central bank has lowered rates three times, each by 25 basis points, positioning itself as the first in the G7 to initiate a rate-cutting cycle

This decision was largely influenced by a series of economic factors that continue to unfold in the Canadian economy.

The primary catalyst for the recent rate cuts is the easing of inflationary pressuresIn its announcement, the Bank of Canada’s governing council noted that overall inflation is gradually decreasing, especially amidst a backdrop of ongoing supply glut that is exerting downward pressure on pricesWhile rising housing costs and certain service prices still contribute to inflation, the overall trend appears to indicate a moderation in inflation.

Furthermore, a slowdown in Canadian economic activity provides another justification for the rate cutsInitial data shows that economic activity in Canada noticeably slowed in June and July, with signs of cooling in the labor marketWage growth continues to outpace productivity gains, suggesting an imbalance that necessitates intervention

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The objective of the rate cuts is to lower borrowing costs, thereby stimulating economic recovery and preventing a deeper downturn in the economy.

However, despite the easing inflation, the risks surrounding it have not been fully eliminated, and the future policy direction remains uncertainMacklem cautioned that the potential for rising inflation persists, especially as the base effect – which influences year-over-year changes in inflation rates based on previous year data – gradually diminishesAs this effect wanes, there could be renewed upward pressure on prices.

Macklem pointed out that inflation might face upward pressure later this year, and the magnitude of the increase could exceed expectationsHousing costs remain a significant driver of current inflation, and although the rate of increase in housing prices has slowed, the costs associated with housing are still propping up inflation

Additionally, rising prices in some service sectors complicate the trajectory toward the inflation target, making a swift return to target levels challenging.

Even with the looming fears of inflation rising, Macklem indicated that the central bank could still choose to lower rates furtherShould inflation decline in line with the bank's expectations, a continued decrease in the policy rate would become a logical choiceHe emphasized that each decision regarding monetary policy will be adjusted based on the latest economic data to ensure inflation returns sustainably to the target of 2%, while supporting economic growth.

The markets responded to the recent interest rate cut with a modest appreciation of the Canadian dollar, reflecting that market expectations regarding the central bank's policy have been largely factored inThe U.Sdollar saw a temporary decline against the Canadian dollar, indicating that investors generally viewed the Bank of Canada's decision as anticipated

However, with the overall weakening of the U.Sdollar, the Canadian dollar's response remained relatively muted.

Attention is now shifting toward the future path of monetary policy, especially given that inflationary risks have not been entirely alleviatedAnalysts are keenly observing whether the Bank of Canada will maintain its accommodative stanceThe financial blog Zero Hedge suggests that the global trend of interest rate cuts may be nearing an end, particularly in countries facing significant price increases and currency depreciation pressures, such as Hungary, which may have reached the end of its easing cycleHowever, the Bank of Canada's position continues to remain relatively dovish, with expectations of further rate cuts in the coming months until inflation is brought under control.

As the first G7 country to embark on a rate-cutting cycle, Canada’s monetary policy decisions may serve as a vital reference point for other developed economies

Following Canada’s lead, the European Central Bank has also implemented similar easing measures, and the Federal Reserve is anticipated to consider rate cuts at its September meetingThis implies that globally, prolonged monetary easing policies could be on the horizon, especially as developed economies grapple with the dual pressures of economic slowdown and inflation.

The actions of the Federal Reserve are particularly crucialIf it opts for an interest rate cut in September, global financial markets could adjust expectations even further, particularly regarding the U.Sdollar's value and U.STreasury yields, which may act as bellwethers for global capital markets.

In summary, the Bank of Canada's consecutive rate cuts reflect its concern over economic weakness and its confidence in easing inflationHowever, the risk of inflation rebounding remains, particularly as base effects dissipate, which could lead to rising prices once more