BoC slashes interest rates by 50 basis points: What's next for CRE?

  10/23/2024 |   SHARE
Posted in Commercial Real Estate by Vanguard Realty | Back to Main Blog Page

Key highlights

• The BoC has historically been hesitant to adjust rates more than 25 bps at a time, so today’s decision to cut Canadian interest rates by 50 bps likely reflects concerns about a slowing economy and the risks of deflation
• Inflation in the third quarter of the year was lower than BoC estimates; the rate in September fell to 1.6%, the first time this rate has been below 2% in more than three years
• The employment rate has been trending downward as employment growth lags population growth; on a year-over-year basis, employment was up 1.5% in September, while the population (aged 15+) increased 3.6%
• When a large cut is announced, it demonstrates a concern that consumers are running out of gas and that the BoC is hoping to ignite the markets before tipping into a recession
• Today’s BoC rate announcement is surely welcome news; however, a more tangible CRE recovery – defined by transaction activity – is still only percolating, rather than materializing in the market
• Even with a cut of this magnitude, CRE transactions will likely remain on the sidelines until mid-2025, when there is confidence that monetary conditions have balanced

BoC slashes Canadian interest rates by 50 basis points

Unprecedented times call for unprecedented action – this was, if anything, the guiding principle throughout the COVID-19 pandemic, as the world came to a collective standstill. Now, with the pandemic firmly in our rearview mirror, the Canadian economy finds itself at a rather precarious point in its recalibration. Years ago, Canadian interest rates began to climb in response to rising inflation concerns. The Bank of Canada’s (BoC) decision to cut interest rates by 50 basis points (bps) today, however, reflects concerns about a slowing economy and the risks of deflation. Currently, the economy is experiencing more supply than demand and prices are falling. Still, employment growth is positive and GDP has nudged up from a soft landing.

Leading up to today’s BoC rate announcement, the market wasn’t questioning whether or not the BoC would cut rates; but rather, by how much. Expectations for consecutive cuts have been fueled by cooling inflation. With Canada's annual inflation rate slowing more than expected in September to 1.6% (the smallest annual increase in consumer prices since February 2021), the writing for further cuts was seemingly painted across the wall.

However, the BoC has historically been hesitant to adjust rates more than 25 bps at a time, and today’s decision may confirm growing fears pertaining to the dwindling strength of Canada’s economy and job market. In the past, larger-than-expected adjustments to lending rates have indicated a crisis – is today’s decision confirmation of turbulence ahead, or a corrective measure that will help the economy maintain stability? More importantly, what does today’s interest rate decision mean for the Canadian commercial real estate market as we approach the final stretch of 2024?

Canada’s softening labour market comes to the forefront

At the BoC’s rate announcement in September, it became clear that attention was shifting from inflation data to weakening labour market data. BoC Governor Tiff Macklem acknowledged the need to shift policy focus from inflation control to boosting the Canadian economy.

As the inflation rate fell to 1.6% in September, the employment rate has also been trending downward as employment growth lags population growth. On a year-over-year basis, employment rose 1.5% in September, while the population (aged 15+) increased 3.6%.

The participation rate—the percentage of the working-age population that is employed or looking for a job—also dropped in September, the third decline in four months and the continuation of a downward trend since late 2023. Changes to Canada’s Temporary Foreign Worker (TFW) program, which include a 10% cap on low-wage temporary foreign workers across Canada, came into effect on September 26th. The Canadian government hopes that these modifications to the program will ensure employers “make a greater effort” to hire available Canadian talent before turning to foreign workers. Over the next 90 days, the TFW program will be reviewed and, where necessary, modified further.

Canada’s services economy continued a downward trend in September; activity and new business declined at accelerated rates, which was attributed to geopolitical uncertainty and expectations of lower interest rates. The headline Business Activity Index was 46.4, down from 47.8 in August and the fourth consecutive month that new sales volumes fell. The latest decline was the most significant since December 2020. The sector also recorded a second successive monthly decline in staffing levels – the steepest recorded since July 2020.

At the same time, confidence in the outlook for the services economy rose to a six-month high in September as businesses forecast increasing sales in the coming year, based partly on expectations of further interest rate cuts.

Canada’s GDP growth accelerated from 1.8% in Q1 to 2.1% in Q2. But expectations for Q3 are lower, anticipated to be in the range of 1.0% to 1.5%, and increasing the likelihood of more BoC rate cuts. “When we consider the decisions put forth by the Federal Reserve and the Bank of Canada, we are reminded that they do everything for a reason,” notes Raymond Wong, Head of Data Solutions at Altus Group. “When a large cut, like this one, is announced, it demonstrates a concern that consumers are running out of gas and that the BoC is hoping to ignite the markets before tipping into a recession.”

Will another cut inspire movement across the Canadian commercial real estate market?

The revival of the Canadian commercial real estate market undoubtedly hinges on the continued downward trajectory of interest rates. With this in mind, today’s BoC rate announcement is surely welcome news; however, a more tangible CRE recovery – defined by transaction activity – is still only percolating, rather than materializing in the market.

“Even with a cut of this magnitude, CRE transactions will likely remain on the sidelines until there is confidence that we have – more or less – returned to balanced monetary conditions,” notes Peter Norman, Head of Economic Consulting at Altus Group. “As I’ve said in the past, the point of rate cuts is to stimulate the economy, but they typically do so with fairly long lags. Investors want a relatively stable rate environment before they start transacting again, so I would expect activity to pick up sometime in mid-2025.”

Right now, the market is pricing in an additional cut at the December meeting. Although the expectations for a 25 bps cut or a 50 bps cut appear varied (and ever-changing), a 25 bps cut appears most aligned with the BoC’s cautious approach to economic recovery.

“We are seeing increased activity across the Canadian commercial real estate market, but not in the tangible sense,” adds Wong. “There is an uptick in interest, and there is more stability in the bid-ask expectation between buyers and sellers. Right now, it’s still costly to borrow money, but with each consecutive cut, investor sentiment improves in anticipation of future transactions.”

Today’s BoC rate announcement should also serve as a boost in sentiment on the development side, although further cuts are needed to inspire a meaningful boost in activity. “Developers have told us before that we will need to see cuts of 200 to 300 bps to really move the needles on pro formas,” adds Norman. “We are now 125 bps into a cutting cycle so, once again, I think we can expect a surge in confidence sometime in 2025.”

Source: Altus Group

Canadian Commercial Real Estate Markets, Commercial Market Trends, Commercial Real Estate, Commercial Real Estate Investments