By Max Sato
(MaceNews) – The Bank of Canada is expected to leave its policy interest rate at a 22-year high 5.0% on Wednesday after raising it by 25 basis points each in June and July in the wake of weak second quarter GDP data, but the outlook remains uncertain as to whether the bank is done with credit tightening launched 18 months ago.
The BOC has raised its target for overnight lending rates by a total of 475 basis points (4.75 percentage points) since March 2022, jacking up the key rate through 10 increases from its record low of 0.25%. The bank only paused twice, in March and April this year, during the current tightening cycle aimed at bringing inflation back to the 2% target.
The Canadian economy unexpectedly contracted in the April-June quarter, being flat (-0.0%) on quarter, or dipping an annualized 0.2%, following solid 0.6% growth (2.6% annualized) in January-March. Household spending was sluggish, growing just 0.1% on quarter (0.2% annualized) after surging 1.2% (4.7% annualized) in the previous quarter.
In its quarterly Monetary Policy Report released in July, the bank forecast that Canada’s GDP would grow at an annualized pace of 1.5% in April-June on resilient consumer spending, and that solid growth would continue at 1.5% in July-September. But the latest data suggests otherwise: The GDP fell 0.2% on quarter in June and the advance estimate by Statistics Canada is a flat reading for July.
The contraction in the second quarter was not so stunning “given a massive civil servant strike, numerous wildfires that crimped oil production, and some inevitable giveback from Q1’s surprising strength,” said Douglas Porter, chief economist at BMO Financial Group. He also noted that the GDP contracted slightly at an annualized 0.1% in October-December.
Despite a rebound in consumer inflation in July, Porter said he believes the case for the bank to pause this week is now overwhelming. “Between the half-point rise in the unemployment rate in the past three months — a clear and present warning sign — and the big slowdown in GDP, it’s quite apparent that past rate hikes are now weighing heavily on households, and that it’s a matter of time until that translates into cooler underlying inflation trends,” he said.
After the July rate hike, Bank of Canada Governor Tiff Macklem told a news conference that “monetary policy is working” as consumer inflation had come down to 3.4% in May from a recent peak of 8.1% hit in June last year. But he quickly added that “underlying inflationary pressures are proving more stubborn.”
Since then, the year-on-year increase in the total CPI eased further to 2.8% in June but ticked up to 3.3% in July.
In the bank’s quarterly Monetary Policy Report for July, CPI inflation is forecast to be around 3% next year before gradually declining to 2% in the middle of 2025.
The latest data showed that Canada’s labor market is showing further signs of cooling after a strong start to the year. Employment unexpectedly declined 6,400 in July after surging 59,900 in June while and the unemployment rate continued to rise to 5.5% from 5.4% in June and 5.2% in May, up from the multi-decade low of 4.9% hit a year earlier.
The August jobs data due on Friday is expected to show employment will rebound by 20,000 from but that the jobless rate will also rise to 5.6%.
The BOC expects Canada’s GDP to grow 1.8% this year before slowing to 1.2% next year and picking up to 2.4% in 2025.
BMO’s Porter forecasts modest 0.3% growth in GDP in the July-September quarter and a small contraction in October-December. BMO has now revised down its GDP forecast to just 1.1% for 2023 from 1.6% projected earlier and to 0.6% next year from 0.8%.
Porter said he cannot definitively say that BOC’s rate hikes are completely done.
The strong U.S. economy will keep some pressure on underlying prices and leave the door ajar for further moves by the Federal Reserve, which would put more downside pressure on the Canadian dollar, pushing up import costs, he said.
“Canada’s own inflation story could remain a bit of a challenge in the next few months, similar to the back-up seen in July,” Porter pointed out. “Much less friendly base effects and the recent rise in oil and some food products threaten to push inflation higher for a spell.”
Macklem said in July that the bank’s policymakers are trying to balance the risks of under- and over-tightening monetary policy. “If we don’t do enough now, we will likely have to do even more later,” he said. “If we do too much, we risk making economic conditions unnecessarily painful for everybody.”
Looking ahead, the governor said the bank will be taking each decision based on the information available at the time.
“As in the U.S., don’t expect Governor Macklem to formally declare that rates have definitely peaked,” Avery Shenfeld, chief economist at CIBC Capital Markets, wrote in a report last week. “He’ll need to see more disinflationary momentum for that, and it could be some months before we’ll have enough labour market slack for the bank to be comfortable in stating that rates are high enough to do the job.”
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Contact this reporter: max@macenews.com
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