The Bank of Canada raised interest rates for an eighth consecutive and potentially final time, saying it expects to move to the sidelines and weigh the impact of its rapid tightening.
(Bloomberg) — The Bank of Canada raised interest rates for an eighth consecutive and potentially final time, saying it expects to move to the sidelines and weigh the impact of its rapid tightening.
Policymakers led by Governor Tiff Macklem increased the benchmark overnight lending rate by 25 basis points to 4.5% on Wednesday, the highest level in 15 years. Bonds rallied and the loonie dropped.
While the quarter percentage point hike matched expectations of markets and economists, most analysts didn’t see the central bank explicitly declaring a potential end point.
Canadian government bond yields fell as investors digested the central bank’s indication it will hold rates while assessing how the economy evolves. The loonie dropped as much as 0.4% to C$1.3425 for a US dollar after the decision.
Inflation is now forecast to fall back to 3% by midyear and return to the 2% target in 2024. Officials flagged falling three-month core measures as a signal that underlying price pressures have peaked.
In the quarterly monetary policy report published alongside the decision, officials said the economy is still overheating. But growth is expected to decelerate rapidly as rate hikes weigh on household spending and help to bring inflation back within the bank’s inflation target by the middle of this year.
“If economic developments evolve broadly in line with the MPR outlook, Governing Council expects to hold the policy rate at its current level,” the bank said in the rate statement.
Still, policymakers cautioned more hikes may be needed if economic data surprise to the upside. The bank “is prepared to increase the policy rate further if needed to return inflation to the 2% target.”
‘Unexpected Guidance’
The conditional pause — the first among Group of Seven central banks — suggests policymakers are convinced the current rate is restrictive enough to restore price stability.
Macklem and his officials “provided some unexpected guidance that this may be the peak” for rates, Andrew Grantham, an economist at Canadian Imperial Bank of Commerce, said in a report to investors. He predicted that “the economy will indeed evolve in-line or even a little weaker than the bank suspects, and that today’s hike in interest rates will indeed mark the final one of this cycle.”
In their report, officials raised their estimate of economic growth in 2022 to 3.6% and forecast a 1% expansion this year, up from 3.3% and 0.9% in their October projections. The chances of two consecutive quarters of negative growth, a so-called technical recession, are nonetheless seen as “roughly the same” as a small expansion in 2023.
Beyond slowing core measures, policymakers flagged global supply chain conditions and lower energy prices as reasons the central bank sees inflation coming down “significantly” this year.
The Bank of Canada, which led its global peers in raising rates rapidly last year, could now be laying out a blueprint for how they pivot to pausing.
Globally, the economic outlook is improving amid Europe’s resilience during an energy crisis, China’s reopening, and subsiding inflationary pressures from declining commodity prices and easing supply challenges.
For Canada, assessing the balance of risks between over and under-tightening monetary policy is complicated by a mixed data picture. While headline inflation has fallen to 6.3% from a peak of 8.1% in June, expectations remain elevated. A tight labor market continued to add jobs at the end of last year, and there’s little evidence yet of any rapid gearing down of economic growth that could allow supply to catch up with demand.
Still, Canadian households — among the most indebted among advanced countries — continue to feel the pinch of higher rates and rising prices for shelter and food. The nation’s housing activity has slowed considerably, and consumption spending is expected to decline further.
“There is growing evidence that restrictive monetary policy is slowing activity, especially household spending,” the bank said in its statement.
Officials flagged sticker services price inflation as the biggest upside risk to their outlook.
Macklem and Senior Deputy Governor Carolyn Rogers will shed more light on the bank’s thinking in a press conference at 11 a.m. in Ottawa.
Wednesday decision marks the first time in the Bank of Canada’s history that the public will get a glimpse of its interest-rate setting process, joining central banks such as the US Federal Reserve and Bank of England in sharing records of their policy meetings. A minutes-like summary of the bank’s deliberations will be published on Feb. 8.
(Updates with economist reaction)
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