The Bank of Canada has been lowering interest rates, but more cuts are still needed for affordability.

The Bank of Canada (BoC) began a change of policy in 2024 by instigating interest rate cuts. It cut the overnight rate by 25 basis points at its policy meeting on June 5th, 2024, and then cut the rate by another 25 basis points at its July 24th meeting. This has marked a shift towards an easing monetary policy cycle from the previous tightening cycle that began with its first-rate hike in March 2022.

In June, the target policy rate was cut by 25 basis points, from 5.0% to 4.75%, but while the first-rate cut was welcome news for many Canadians, even after a second cut in July, interest rates remain elevated. It will likely take multiple cuts to the policy rate for a meaningful impact on affordability. We are expecting the BoC policy rate to decrease to 4.0% by the end of 2024. That would be a total of 100 basis points eased this year.

Incoming data will determine future cuts

The pace and frequency of future policy rate cuts is conditional on incoming data, which focuses heavily on inflation continuing to slow toward 2.0%, the midpoint of the BoC’s 1.0% to 3.0% target range. As of June 2024, headline inflation stood at 2.7% year-over-year, the sixth consecutive month below 3.0%. Meanwhile, core inflation, which excludes food and energy, was 2.9% in June, up from 2.7% in April and proving sticky near the 3% upper target.

Along with inflation, the BoC looks at developments in the labour market, where job gains have slowed relative to last year but remain positive through the first half of 2024. Wage gains for permanent employees continue to run above 5.0% year-over-year and that supports consumer spending, but puts pressure on costs to businesses, which risk being passed through to inflation.

Canada must consider the U.S. rate to avoid higher import costs

The BoC also needs to be wary about how far it diverges from the U.S. Federal Reserve policy rate, which continues to hold at 5.5%. Should the Canadian policy rate decrease further while the U.S. policy rate remains unchanged, it could soften the Canadian dollar relative to its U.S. counterpart. That risks importing inflation as goods and services coming north across the border would become relatively more expensive.

Even with the advent of policy rate cuts, interest rates still pose headwinds, as previous rate hikes to date continue to weigh on consumer spending and affordability.

Vehicle sales growth is slowing

Relating that to vehicles, we’re starting to see sales growth slowing. Seasonally-adjusted sales have declined relative to the recent peaks we saw earlier in the year. A lot of the rebound in last year’s sales were due to recovery on the supply side. North American production has returned to near pre-pandemic levels, which combined with slowing sales growth, is leading to a buildup of inventories. That’s putting some downward pressure on prices, both for new and used vehicles.

Our latest forecast for 2024 is 1.76 million vehicle sales, and we’re expecting the sales rate to stay flat over the next little while as interest rates remain restrictive. The CDK software outage at the end of June that affected a large number of dealerships was a temporary shock relative to annual vehicle sales, and unlikely to have a meaningful impact on the year’s sales overall.

There is uncertainty around near-term developments which can be difficult for dealers to work with. As further policy rate cuts will be dependent on how the BoC interprets incoming data, we’ll have to wait and see how the rest of the year plays out.