The Bank of Canada raised interest rates for a second straight meeting, keeping the door open for more hikes as it pushed back inflation’s return to its 2% target.
(Bloomberg) — The Bank of Canada raised interest rates for a second straight meeting, keeping the door open for more hikes as it pushed back inflation’s return to its 2% target.
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 bank provided little guidance on the future path of borrowing costs in the rate statement. But Macklem later told reporters he and his governing council debated holding steady this time in order to confirm a need for more tightening.
Macklem said officials ultimately decided to raise borrowing costs because “the cost of delaying action was larger than the benefit of waiting,” adding that the bank is prepared to hike rates further “if new information suggests we need to do more.”
The communications suggest that while policymakers are increasingly sure they’re near the end of the hiking cycle, they’ll wait to see more economic data first.
“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.
Swaps traders, however, upped their bets for a follow-up hike at the bank’s next meeting on Sept. 6, putting the odds at a little less than a coin flip.
The loonie jumped to its highest intraday level since June 27, trading at C$1.3184 per US dollar at 2:12 p.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 4.659% — the lowest in a week.
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. New forecasts in the monetary policy report that accompanied Wednesday’s decision illustrate why policymakers were forced to restart their tightening campaign last month.
Upward revisions to consumption mean Canada’s economy will end up averaging about 1% growth in the second half of this year and first half of 2024, according to the bank’s new forecasts. Officials now predict the output gap will close nine months later than previously anticipated, early next year. At his press conference, Macklem confirmed policymakers don’t expect a recession.
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. Delaying the projected return to price stability suggests Macklem and his officials are struggling with their primary job, even as higher inflation expectations risk becoming further entrenched.
His hike underscores 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 have said 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.” They said they will be closely watching excess demand, inflation expectations, wage growth and corporate pricing behavior as they weigh their next moves.
They reiterated the Bank of Canada’s commitment to getting inflation all the way back to the 2% target, but noted 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.
The latest revision to the inflation outlook is due to more persistent excess demand and higher-than-expected prices for homes and goods, the bank said. Officials flagged the potential for inflation expectations to prove more stubborn as a key upside risk.
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 supporting unexpectedly strong household spending in the first half of the year.
Characterizing Wednesday’s move as “a moderately hawkish hike,” the Bank of Montreal said it’s adjusting its medium-term outlook as a result.
“While we are not looking for further hikes this year, we are tweaking our rate call in light of the bank’s view on growth and inflation — we now see rate cuts beginning only in the second quarter of 2024, one quarter later than our prior view,” Chief Economist Doug Porter said in a report to investors.
For his part, Macklem reiterated at his press conference that “it’s still too early” to be talking about potential cuts.
–With assistance from Derek Decloet.
(Updates throughout with comments from press conference.)
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