The Bank of Canada raised interest rates for a second straight meeting, pushing back the timeline for inflation’s return to target while revising growth upward.
(Bloomberg) — The Bank of Canada raised interest rates for a second straight meeting, pushing back the timeline for inflation’s return to target while revising growth upward.
Policymakers led by Governor Tiff Macklem increased the overnight lending rate on Wednesday by 25 basis points to 5%, the highest in 22 years. The move was expected by most economists in a Bloomberg survey, and markets had put the odds at around three quarters.
The loonie jumped to its highest intraday level since June 27, trading at C$1.3157 per US dollar at 10:33 a.m. Ottawa time. The benchmark two-year yield, which had plunged earlier after US inflation came in at a lower rate than expected, fell further to 4.675%.
The bank provided little guidance on the future path of borrowing costs in the rate statement, but reiterated that it “remains resolute” in its commitment to achieving price stability.
In the accompanying monetary policy report, officials forecast inflation will stay around 3% for the next year before gradually declining to the 2% target in mid-2025, two quarters later than previous projections. The economy is seen averaging about 1% growth in the second half of this year and first half of 2024, an upward shift from the stall expected earlier. The bank now predicts the output gap will close nine months later than previously anticipated, early next year.
The substantial forecast adjustments illustrate why policymakers restarted their tightening campaign in June. The central bank’s attempt to pause interest rates earlier this year proved untenable in the face of stubborn price pressures and surprisingly robust consumption growth.
But delaying the return to price stability suggests the bank is struggling with its primary job, even as higher inflation expectations risk becoming further entrenched.
“While the Bank of Canada didn’t shut the door to more monetary tightening, Canadians might finally be seeing some light at the end of the rate-hiking tunnel,” Royce Mendes, head of macro strategy at Desjardins Securities, said in a report to investors.
Policymakers decided to hike “in light of the accumulation of evidence that excess demand and elevated core inflation are both proving more persistent, and taking into account its revised outlook for economic activity and inflation,” the bank said.
Macklem will shed more light on the decision during a press conference at 11 a.m. in Ottawa.
His hike highlights the challenges faced by central bankers around the world as they try to nail down how high borrowing costs will need to rise in order to fully rein in price pressures. Officials at the Federal Reserve are saying US rates will need to go higher. The European Central Bank isn’t done hiking yet, and Bank of England policy is becoming a national obsession in the UK.
Macklem and his officials remain “concerned that progress towards the 2% target could stall, jeopardizing the return to price stability” and will be closely watching excess demand, inflation expectations, wage growth and corporate pricing behavior.
The statement reiterates the Bank of Canada’s commitment to getting inflation all the way back to the 2% target, but notes that there are challenges ahead.
“The next stage in the decline of inflation toward target is expected to take longer and is more uncertain,” the bank said in the monetary policy report, citing elevated prices for services and uncertainty about expected inflation as key reasons.
The latest revision to the inflation outlook is due to more persistent excess demand, and higher-than-expected house and tradeable goods prices, the bank said, adding that a key upside risk is inflation expectations could prove more stubborn.
The bank said that the stickiness of core inflation in Canada suggests that inflation may be more persistent than originally thought, and that a similar pattern also exists in other economies.
Policymakers see a tight labor market, accumulated household savings, pent-up demand for services, government spending, and strong population growth from higher levels of immigration as key factors leading to the unexpected strength of household spending in the first half of this year.
Spending on rate-sensitive goods such as furniture, clothing and recreational equipment was “surprisingly strong” and based on recent data, strength in goods consumption “seems to have continued,” while spending on services has been robust, according to the report.
“Greater excess demand and more stubborn core inflation are sustaining underlying price pressures,” the bank said. “Slowing domestic demand is central to the anticipated decline in inflationary pressures.”
–With assistance from Derek Decloet.
(Updates with market and economist reaction.)
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