The Bank of Canada (BoC) cut its overnight rate by 25 basis points to 2.25% this morning, citing weak investment and falling demand. It also reminded Canadians that monetary policy is meant to keep inflation low and stable—then promptly put that on the sideburner. The BoC warned that monetary policy won’t fix the current headwinds, but expects economic erosion to control inflation. Apparently, the inflation mandate has been outsourced to economic devastation, and a resilient economy means life is about to get much more expensive.
Bank of Canada Says Lower Rates Won’t Address Current Economic Issues, Cuts Anyway
The central bank cited eroding economic factors as the primary support for rate cuts. It points to GDP’s 1.6% contraction in Q2, driven by a shock to exports, and weak business investment due to economic uncertainty—primarily around tariffs. They further cite unemployment sitting at 7.1% in September, and slowing wage growth. None of these are directly addressed by monetary policy, but factors the BoC attributes primarily to tariffs.
“Monetary policy cannot offset the long-term implications of US tariffs or other sources of structural change. The primary focus of monetary policy is to maintain low and stable inflation,” explained the BoC in its accompanying report.
To sum up the first few minutes of the BoC conference—it cut rates to support the economy, though it doesn’t believe the easing can actually do much for a structural change… cool?
BoC Dismisses Inflation Warnings, Refers To Feelings Of Inflation
Don’t let the above quote mislead you, the BoC reiterated its primary mandate is maintaining low and stable inflation, but it struggled to explain how this factored into its decision. Headline CPI came in at 2.4% in September, “higher than the Bank had anticipated” and climbed to 2.9% excluding taxes. It further explained that its preferred core inflation measures also remain around 3%, but “underlying” inflation suggests inflation is more like 2.5%.
For those curious what underlying inflation is, earlier this month the BoC explained it’s “not a statistic,” but more of a feeling. The BoC is taking a page out of weather forecasting—inflation is 3.0%, but it feels like 2.5% when adjusted for the bullshitidex. They see underlying inflation um, feeling like 2.0% in the coming months. We imagine underlying inflation also told the Bank’s Governor that he’s smart, handsome, and gosh darnit—people like him.
BoC Addressing Slow Investment & Write-Offs, Little Mortgage Relief
The aggressive rate cuts are praised by the real estate industry, but it may not prove to be the win anticipated. The overnight rate influences short-term borrowing costs, only helping with variable-rate mortgages. Fixed-term mortgages are influenced by Government of Canada (GoC) bond yields, which move with inflation expectations. The 5-year GoC bond yield, which influences 5-year fixed-rate mortgages, climbed 10.8 basis points (bps) on the cut, rolling back 3 weeks of progress in a single day. In other words, the initial reaction was higher borrowing costs for people who don’t want to play rate roulette.
The BoC’s justification here is they expect the drivers of inflation to be tempered by collapsing economic activity. They see higher prices via imported inflation and trade disputes mitigated by falling demand due to worsening economic conditions. The excess supply will lower prices for those who can afford it, so hope for that downturn, otherwise life is about to get much more expensive.
Does it sound like the BoC’s actions are in conflict with its words, and they’re leaving something out? It may have been buried on page 32 of its accompanying report. “Investment will slow, and some existing capital could be written off or diverted toward a less profitable use,” explained the central bank—suggesting they may be pre-emptively addressing a crisis not yet visible to the public.
Canada’s central bank may have reiterated its belief that monetary policy is for inflation control, but it’s demonstrating the exact opposite. BoC research found that monetary policy takes between 18 to 24 months to reach the market. However, it’s using monetary policy as a short-term tool to address problems it acknowledges are out of policy reach—at the expense of higher inflation. Its sole supporting argument being that economic conditions will erode to the point where it will temper its stimulus. Oh my.
As you note above, the big issue for the BoC is that, presumably, they understand that the inflation is not some mysterious magical spell, but caused directly by debasing the currency. As such, lowering rates theoretically means more inflation since more people will borrow, because rates are slightly lower.
Similarly, when inflation is high, the BoC is bound to increase rates to make borrowing more expensive. The problem with this construct (called Modern Monetary policy) is that humans are smart, and despite the theory being pretty good circa 1995, it has ended up failing. Since everyone knows that banks create money by originating loans and therefore debase the currency, along with govt debt doing the same thing, as long as CPI stays low, you can create ‘gdp growth’ and hide inflation, therefore keeping the good times going despite huge risks to the economy from there now being 2, 3, 4 times as much money as there was 11y ago.
For Canada, this point is exactly why we are here. The M3 (broad money supply) has doubled since 2015 to 4 Trillion dollars. During that same period Cumulative cpi went from 127 to 165 or up 29.9%. This means that the Money supply grew at roughly 3x as fast as CPI. GDP in USD rose from 1.9Tr to 2.2Tr in 2024. so USD nominal GDP rose by 11.5%. Now USD cpi went up at the same time by 37%, so Canada’s real GDP is down by 25.5%.
So for the bank of Canada, they should know exactly what the problem is, high collateral prices being used to justify a massive expansion in the M3. The problem now is, if they try to correct the housing prices, they will end up with a serious problem – a M3 contraction, and deflation. Think Japan since 1990. So everyone is now stuck in this loop of trying to maintain ridiculous housing prices, and at the same time manage the fact that our economy has been contracting because of lack of investment and far far too much money stuck in residential real estate.
The biggest problem is that eventually the dam will break and housing will collapse, particularly if the BoC tries to maintain high housing prices. Unless wages, gdp, and investment are able to somehow bridge the gap between existing housing prices and gdp, the end is going to just get worse, and at 1-2% the BoC has no real tools to address it, particularly as govts, banks keep creating ever larger amounts of net new money.
This is not good. And the diff btwn long term & short term rates quite something. The Minsky moment approaches. At least it’ll lower inflation right :/