The Bank of Canada lowered its policy interest rate -- the target for overnight lending rates -- by 25 basis points to 4.75 percent to help reduce high mortgage rates and other borrowing costs in light of easing inflation and slower economic growth that is allowing the key rate to be"not as restrictive" as it has been. It is the first interest rate cut by the bank since March 2020 but the latest move is a different type of a rate relief compared to three emergency rate reductions, from 1.75 percent to 0.25 percent, at the early phase of the pandemic when demand plunged across the world.

At the same time, the bank said it is continuing its policy of quantitative tightening to trim the bank's balance sheet to a normal level. The process is likely to end sometime next year when the bank will resume normal purchases of government bonds, Governor Tiff Macklem told a news conference, sticking to the official outlook."With the policy rate at 4.75 (percent), monetary policy remains restrictive," Macklem said."In fact, with inflation 2.7 percent and underlying inflation roughly in 3 and 3.25 percent, we still need restrictive monetary policy. There is still some work to do to get inflation back to target." In that sense, the bank needs to"continue QT" and"continue to normalize the balance sheet."

In its previous policy announcement on April 10, the bank maintained the key rate at 5 percent for the sixth straight meeting, with bank officials saying they needed to see clearer evidence that inflation was on its way down to their 2 percent target before lowering the rate from the restrictive level.

"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," the bank said."Recent data has increased our confidence that inflation will continue to move towards the 2 percent target. Nonetheless, risks to the inflation outlook remain," it said.

The bank repeated its recent statements:"Governing Council is closely watching the evolution of core inflation and remains particularly focused on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour."

In his opening remarks at a news conference, Governor Macklem said,"If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2 percent target continues to increase, it is reasonable to expect further cuts to our policy interest rate. But we are taking our interest rate decisions one meeting at a time." Asked more than once whether the bank will cut its policy rate again in the July 24 policy announcement, Macklem remained tight-lipped, repeating his comment that the bank's policymakers are"taking our decisions one meeting at a time."

He did say, however, that if the pace of easing inflation remains"gradual," the pace of any future rate cuts would also be"gradual," in sharp contrast to the 10 rate hikes totaling 475 basis points (4.75 percentage points) that the bank conducted between March 2022 and July 2023, taking the overnight rate to a 22-year high of 5 percent from its record low of 0.25 percent.

"We don't want monetary policy to be more restrictive than it needs to be to get inflation back to target," the governor said."But if we lower our policy interest rate too quickly, we could jeopardize the progress we've made." The governor warned:"Further progress in bringing down inflation is likely to be uneven and risks remain. Inflation could be higher if global tensions escalate, if house prices in Canada rise faster than expected, or if wage growth remains high relative to productivity."

Asked whether there is a limit to how the Bank of Canada could lower interest rates independently of other major central banks without worrying too much about the impact it may have on the Canadian dollar, Macklem said,"In Canada we have our own currency; we have flexible exchange rates. What that means is that we can gear monetary policy to the needs of the Canadian economy." But the governor also noted that since the Canadian and the U.S. economies are closely linked and their financial systems are integrated, BoC officials take those into account when setting economic forecasts and monetary policy.

"There are limits to how far we can diverge from the United States but we are not close to those limits…and we will continue to get inflation back to target and run monetary policy in Canada within those," he said, without elaborating further.

The Bank of Canada is expected to lower its policy interest rate -- the target for overnight lending rates -- by 25 basis points to 4.75 percent after maintaining it at 5.00 percent for the sixth straight meeting in April, when bank officials said they needed to see clearer evidence that inflation is on its way down to their 2 percent target before lowering the rate from the restrictive level. Since then, data have shown continued easing in consumer inflation and slower economic activity in Canada, opening the door for a June rate cut by the bank ahead of the US Federal Reserve. Some forecasts expect the BoC to wait until July.

Canada's central bank, the Bank of Canada (BoC), announces its monetary policy with regard to interest rates eight times a year. The announcement conveys to the financial markets and investors what, if any, changes in policy might be. The main focus is the target set for the overnight rate. Policy is framed around keeping the annual rate of inflation as measured by the consumer price index (CPI) within a 1 percent to 3 percent range and close to the 2 percent midpoint over the longer-run. To this end, the BoC also monitors an adjusted measure of the CPI that excludes a range of volatile categories in order to get a better handle on underlying trends.

Bank of Canada determines interest rate policy at eight meetings during the year and they are an influential event for the markets. Prior to each meeting, market participants speculate about the possibility of an interest rate change. A post-meeting statement is issued after each meeting. Unlike the Federal Reserve, there are no post-meeting minutes. The Bank has an inflation target range of 1 percent to 3 percent with specific focus on the 2 percent midpoint.

Although the Bank monitors many economic indicators, as indeed all central banks do, the Bank converted its inflation barometer for operational purposes to a consumer price index measure that subtracts eight volatile components to better reflect core inflation. It also takes the foreign exchange rate for the Canadian dollar into its monetary policy decisions.

Monetary policy goals are to aid and abet solid economic growth along with rising living standards. To achieve these goals, inflation is kept low, stable, and predictable. The inflation control target is at the heart of Canadian monetary policy that the Bank and the Government have established. The level of interest rates and the exchange rate determine the monetary environment in which the Canadian economy operates.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.