The Bank of Canada just cut its key interest rate to 4.75% after years of raising it or holding steady.
In this five-minute video, Motley Fool Canada analysts break it all down. (Prefer to read? There’s a transcript below.)
Transcript
Nicholas Sciple: I’m Motley Fool Canada senior analyst Nick Sciple, and this is the “Five-Minute Major,” here to make you a smarter investor in about five minutes. Today we’re discussing the Bank of Canada’s decision to lower interest rates. My guest today is Motely Fool Canada Chief Investment Officer, Iain Butler. Iain, thank you for joining me.
Iain Butler: Love talking interest rates, Nick.
Nicholas Sciple: Who doesn’t, right? It’s the most boring, most focused-on thing in the stock market. But let’s focus on it again here!
Iain Butler: Important. It is important.
Nicholas Sciple: Boring and exciting, at the same time boring, important, exciting — all the adjectives.
Bank of Canada cuts key interest rate to 4.75%
Nicholas Sciple: Okay, on Wednesday, June 5, the Bank of Canada announced it’s cutting its policy rate to 4.75%, down from the 5% level it had held since July 2023. This makes Canada the first G7 nation to cut interest rates this cycle, which has been a historical hiking cycle going back the past couple of years. Iain, why is the Bank of Canada cutting interest rates right now? And what does it mean for investors?
What the interest rate cut means for investors
Iain Butler: Okay, let’s play. I’ll give you the official statement, and then I’ll put on my layman’s hat — which I only ever wear when it comes to macro and interest rate talk — and try to read between the lines and see what we can come up with. So the official statement was: “With continued evidence that underlying inflation is easing, governing council agreed that monetary policy no longer needs to be as restrictive and reduced the policy interest rate by 25 basis points. Recent data has increased our confidence that inflation will continue to move towards the 2% target.”
Okay. So reading through the lines here, I think the government or the Bank of Canada is saying that we’ve done our best to quash the animal spirits that had become increasingly rampant in the Canadian economy. And when I say Canadian economy, I especially mean Canadian housing. The Canadian housing situation was, in my opinion, getting out of control. So now they have data. I don’t fully understand how they calculate these things. But data has been calculated that indicates they can take their foot off the breaks and sort of be less restrictive. They’ve tamed the spirits for now, and away we can go at our own free will, supposedly. So the thing is, we’re only talking about 25 basis points here. What really matters, as is the case with all things in the financial world, is what’s next. This was rather telegraphed and I think the market is expecting more from the Bank of Canada. So where this gets interesting is if indeed we get a series of cuts from here. I think this is an important start. Obviously, you gotta start somewhere and they didn’t go big and go 50 basis points or anything like that. But we’re gonna find out in the months ahead whether this truly is an easing cycle that we’ve entered for the first time in over four years.
The kinds of stocks that could benefit from lower rates
Nicholas Sciple: There’s a natural follow-up question to that, Iain. Are there any steps investors can take to prepare their portfolio for what could be the signal to a larger shift in monetary policy? Certainly in Canada, and maybe Canada is the first domino for a larger monetary shift on a global basis.
Iain Butler: This is where it gets interesting. I mentioned that we don’t really know much — or think much — about macro. Interest rates are important. But my head goes to two places here. First off, dividend-paying stocks and even more specifically real estate investment trusts, also known as REITs, and the Canadian banks, and then somewhat less directly — hopefully, we can get to this with the time allotted — are Canadian energy companies.
Impact on REITs (real estate investment trusts)
Iain Butler: So quickly, REITs. Speaking to them. They carry a lot of debt, and that debt has become more expensive, which has impacted their earnings and certainly their ability to raise distributions, let alone support their existing distributions. So that’s one angle there, plus REITs are known as interest rate-sensitive securities. So there are alternatives to REITs that income-seeking investors can go to, fixed income and cash accounts being one. Fixed income and cash were attractive when rates have been as high as they are, and that means the yield on REITs had to go higher to make the risk entailed with them more attractive. So rates come down, REITs are going to benefit.
Impact on Canadian bank stocks
The Canadian banks could benefit in a number of different ways. For one, they’ve got a wall of mortgages maturing in the years ahead and lower interest rates will help with those renewals. People be will be better able to afford their mortgages. Banks are also dividend-paying entities.
Impact on Canadian energy companies
I am going to go straight to energy companies because energy companies are the final category where rate cuts aren’t great for the Canadian dollar in the moment, anyway. Energy companies take in revenues in U.S. dollars while their cost base is largely in Canadian dollars. So U.S. dollar revenue goes up when the Canadian dollar goes down, cost base stays the same, that should be good for Canadian energy companies’ profit.
Nicholas Sciple: Lots to follow as this macro story continues to play out. That’s all the time we have for this edition of the “Five-Minute Major.” Thank you, everyone, for joining us, and we’ll see you next time, where we may have even more interest rate talk to discuss!
