It finally happened. After four years of waiting and seeing rates climb higher and higher, the Bank of Canada finally cut its benchmark interest rate by 25 basis points this week. This was the first reduction in over four years, bringing the policy rate down to 4.75%.
While the decision was expected, investors have been waiting on a cut for some time. And nothing was certain until Wednesday morning. However, lower inflation, weaker economic growth during the first quarter, and lower employment growth all fed into the decision.
But what does this mean now for Canadian investors? Let’s get into it.
What happened?
The key to the cut came down to inflation. While inflation has yet to reach the 2% benchmark outlined by the Bank of Canada, enough has been seen for a cut to come into effect. “We’ve come a long way in the fight against inflation,” said Governor Tiff Macklem. “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate.”
So, not only does the Bank believe that a cut was due in June, but Macklem didn’t close the door on perhaps another rate cut coming as soon as July! And as long as inflation continues to fall in the right direction, economists believe this is looking more likely.
The markets react
The rate cut saw a reaction by the TSX, but perhaps not as much as investors would have hoped. Shares on the TSX rose slightly after the announcement, demonstrating a gain of 0.5% after the news. Furthermore, it didn’t see a surge past 52-week highs after investors have seen shares remain around the $22,000 mark for the last few months.
Perhaps part of this comes down to uncertainty over what exactly should happen next. In general, the cut in interest rate generally signals a more accommodating monetary policy. The goal is to stimulate more economic activity, and investors should see this as affecting different areas of the market.
So, let’s get into what investors might expect with a lower interest rate and more cuts on the way.
The impact
There are several ways that a lower interest rate will affect investors. The first is via bond markets. When interest rates fall, existing bonds with higher rates become more valuable, pushing up their prices. New bonds will be issued with lower interest rates, reducing the income for investors buying these new issues.
This will also come down for investment with interest rates. With lower interest rates, traditional savings, and fixed-income investments yield less, pushing investors to seek higher returns in riskier assets like stocks or real estate. Investors might adjust their portfolios to increase their exposure to assets that are expected to benefit from the rate cut, such as equities or high-yield bonds.
And that will likely mean going towards the stock market once more. Lower interest rates reduce borrowing costs for companies, potentially boosting business investments and profitability. This can lead to higher stock prices as investors anticipate better corporate performance.
Furthermore, some sectors, like real estate and utilities, may benefit more as they are more sensitive to borrowing costs. Technology and growth stocks might also see positive impacts as the cost of capital decreases.
Bottom line
While we’re not out of the woods yet, and investors should always stick to their long-term goals, it’s looking like a better investment position for Canadians these days. A lower rate means more cash on hand for everyone. That includes businesses, which can invest back into more growth for their companies. More growth can mean more returns. In the end, at the very least, a lower interest rate will likely lead to higher confidence in the stock market in general.
