The Bank of Canada’s new overnight interest-rate cut shows that the commercial real estate market gain in the long term, say industry leaders.

But Wednesday’s reduction likely means that the sector will continue to feel the pain of higher interest rates for at least a little while.

“Rate cuts from the Bank of Canada are important signals to the market, but typically these decisions have minor economic consequences in the short-term,” said Peter Norman, a vice-president with Toronto-based Altus Group. “The broader implications of interest rate decisions – whether positive or negative – take months to materialize in the market.

“Initially, the impact of these rate cuts is a psychological one.”

As widely expected the BoC reduced its prime rate 25 basis points to 4.5% from 4.75%. That marked the second consecutive monthly cut. Before June, the central bank had not cut the overnight rate for four years, implementing a monetary tightening policy that has seen large reductions in commercial real estate investment, especially among institutional investors.

While Norman was not overly enthusiastic about Wednesday’s cut, he was still glad to see it.

“An interest rate cut changes expectations for where interest rates are going, which influences the decision-making process,” said Norman. “Whether you’re thinking about embarking on a commercial real estate transaction, or you’re deciding whether to move forward on a project, your decisions right now will be largely predicated on psychology. So, the pace of rate cuts is important.”

Subsequent rate cuts signal that the BoC is no longer holding rates, he added. Instead, it’s moving quickly towards bringing interest rates back into balance, inspiring optimism in the market going forward.

Market sentiment soured as the BoC hiked interest rates 10 times in 2022 and 2023 before instituting a prolonged series of holds that continued until early June. Now that the BoC has cut again, the market knows that the hold period is over. As a result, the market can reasonably conclude that it is moving towards a new, stable point, said Altus.

Tiff Macklem, the BoC’s governor, continued to display a softer stance on hikes Wednesday, indicating that the central bank is looking at other ways than inflation reduction to improve the economy.

“As inflation gets closer to the 2% target, the risk that inflation comes in higher than expected has to be increasingly balanced against the risk that the economy and inflation could be weaker than expected,” he said.

The bank’s policy interest rate is moving in a downward direction, but he noted: “We we’re not on a predetermined path.”

Macklem said the bank will make each cut according to its own merits. But Mark Fieder, president of Avison Young’s Canadian business, likes the direction that he sees.

“Today’s announcement from the Bank of Canada will have a positive impact on investor sentiment,” he said. “Commercial real estate return metrics are improving compared to other asset classes, and we expect this will further fuel investor appetite and capital allocation into CRE.”

Although Macklem indicated that the BoC will take a wait-and-see approach on cuts, Fieder expects the bank’s support for cuts to remain consistent.

“We have been in a very uncertain interest-rate environment over the last two years,” said Fieder. “This second rate drop certainly shows the BoC’s confidence in the inflation data and reinforces the fact that we are finally shifting into a different interest-rate regime.”

The cut spelled further divergence between the BoC and U.S. Federal Reserve policy interest rates. While the BoC has displayed an inclination for more cuts, the U.S. Fed had leaned towards hikes until softening its stance recently and suggesting that cuts could occur this year.

For the time being, the Fed is holding its key rate.

Wednesday’s BoC cut raised questions on how long the rare Canada-U.S. rate divergence will continue.

“The Bank of Canada’s decisions later this year will be undeniably influenced by what’s happening in the U.S.,” said Ray Wong, an Altus vice-president. “If our interest-rate decisions don’t align with the U.S., our dollar is at risk.

“Right now, the U.S. has favourable data for rate cuts, but the upcoming election may impact economic policy over the next six months which, in turn, influences our outlook as well. An inflationary environment in the U.S. puts upward pressure on bond yields in the U.S., which limits Canada’s ability to continue cutting rates.”

According to Altus, Wednesday’s cut signals that the BoC is continuing its monetary easing cycle ahead of other central banks.

TD Economist Rishi Sondhi said the BoC was “comfortable enough” to trim its policy rate in spite of the Canada-U.S. divergence.

“The BoC doesn’t appear overly concerned about the recent regression in core inflation trends,” he said in a research note.

TD has targeted a 4.25% overnight rate by year-end 2024. While the ultimate destination may remain the same, the BoC’s “dovish lean” Wednesday raises the risk of more easing than TD has pencilled in.

The current 4.5% mark is still “well north of inflation” and “quite restrictive,” the market will still feel pressure from it, he added.

Pictured: Bank of Canada Governor Tiff Macklem