The Bank of Canada raised the overnight rate by 25 basis points, to 5%, while stating that it will continue with Quantitative Tightening (QT). With the hike, the policy rate is now at its highest level since 2001.
On economic growth the Bank stated that “Canada’s economy has been stronger than expected” and that recent data signals more persistent excess demand in the economy. The Bank also flagged the recent pick up in the housing market and that conditions in the job market remain tight, with wage growth hovering around 4-5%.
On inflation, it stated that while “CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation.” In addition, it noted that “underlying price pressures appear more persistent than anticipated” and that “businesses are still increasing their prices more frequently than normal”. Finally, policymakers re-iterated. their concern that progress towards the 2% inflation target could stall.On the future path of policy, the Bank will “be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the inflation target.” This is unchanged from the April statement.
Accompanying the Bank’s policy statement was a fresh set of forecasts. Real GDP is now seen as expanding by 1.8% this year (versus 1.4% in April), 1.2% in 2024 (1.3%) and 2.4% in 2025 (nearly unchanged). In the near-term, growth is expected to be 1.5% in both the second and third quarters of this year.
Notably, the Bank’s inflation projections have been materially upgraded. By 2023Q4, inflation is seen at 2.9%, versus 2.5% in their April projection. They’ve also pushed out when they see inflation hitting the 2% target, with that now anticipated to happen in the middle of 2025, as opposed to the end of 2024 in their April forecast.
Key Implications
Today’s rate hike demonstrates that the Bank of Canada is not satisfied with the modest cooling in inflation and wage pressures that has been seen since its June hike. As it outlined in the statement, it’s concerned about excess demand and core inflation that are proving to be more persistent than what policymakers had expected.
So, where does policy go from here? The onus is on the incoming data, which we think will show enough weakness over the coming months for policymakers to remain on hold for the next few quarters. We’re already seeing signs that job markets are softening, with vacancies well below prior peaks, the unemployment rate on the rise, wage growth beginning to moderate.
However, this view is not without risks. A big factor behind the persistence in excess demand and inflation noted by the Bank of Canada has been robust consumption. The Bank is counting on household spending slowing down in coming quarters but are cognizant of the risks. Our own forecast sees consumption slowing down materially in coming quarters, with this softness more apparent in 2024. Should household spending prove more resilient than policymakers anticipate, this would offer a pathway to higher rates.
Housing is also clearly weighing on the Bank’s mind, given the recent pickup in activity and recent signs of resilience to its hike in June. The performance of this sector will also play an important role in any decision on rates moving forward.
. With the hike, the policy rate is now at its highest level since 2001.){kind=link}