–Governing Council Remains Concerned About Sticky Underlying Inflationary Pressures, Prepared to Hike Policy Rate further if needed
By Max Sato
The no change in policy was widely expected after the bank raised the key rate by 25 basis points each in July and June, when BOC policymakers said the risk of under-tightening would be greater than over-tightening.
The bank said it is also continuing its policy of quantitative tightening.
The latest policy decision came against the backdrop of still elevated core inflation in major economies and slowing global economic growth in the second quarter of 2023, largely reflecting a significant deceleration in China. Global bond yields have risen, reflecting higher real interest rates, and international oil prices are higher than was assumed in the bank’s quarterly projection provided in July.
Policymakers Wary of Underlying Inflation, Prepared to Act If Needed
“With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5% and continue to normalize the Bank’s balance sheet,” the bank said in a statement. “However, Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed.”
“Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation,” the bank said, repeating its July statement. “In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the 2% inflation target.”
The BOC has risen 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%. Before today’s decision, 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 Bank has certainly left the door ajar to the possibility of more hikes, but unless growth rebounds in Q3 — which we doubt — the BoC is likely done with rate hikes,” Douglas Porter, chief economist at BMO Financial Group, said. “The softer growth backdrop will bring inflation back to 2% over time in our view and in the BoC’s models, even if the short-term CPI outlook is much more problematic.”
“Holding rates steady at the next meeting will require some nerve as the next two CPI reports could see headline inflation approach 4% (the next one is due Sept. 19), and will likely require still-chilly growth and some calming in core inflation,” Porter said.
The BOC will announce its next policy decision on Oct. 25.
Canadian Economy Now in Weaker Growth Period
“The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures,” the bank said.
“Household credit growth slowed as the impact of higher rates restrained spending among a wider range of borrowers,” it noted. “The tightness in the labour market has continued to ease gradually. However, wage growth has remained around 4% to 5%.”
Data released Friday showed 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. It was also due to a decline in housing activity and the drag from wildfires in many regions of the country.
In its quarterly Monetary Policy Report (MPR) 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 GDP contracted slightly at an annualized 0.1% in October-December.
The BOC’s latest forecast made in July is that Canada’s GDP will grow 1.8% this year before slowing to 1.2% next year and picking up to 2.4% in 2025. The bank’s policymakers will update their medium-term projections in their next MPR due on Oct. 25.
Inflationary Pressures Broad-Based, CPI Set to Rise in Near Term
“Recent CPI data indicate that inflationary pressures remain broad-based,” the banks said on Wednesday.
“With the recent increase in gasoline prices, CPI inflation is expected to be higher in the near term before easing again,” it warned. “Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation.
“The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability,” the bank said, repeating its concern.
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, averaging close to 3% in line with the bank’s projection.
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.
Two of the BOC’s core inflation measures have eased only slightly. The year-over-year increase in the CPI trim decelerated to 3.6% in July from 3.7% in June, reaching the lowest since 3.5% in November 2021. The annual rate of the CPI median was steady at 3.7% for a second straight month in July, staying above 3.5% seen in January 2022, when the world had not seen the impact of Russia’s invasion of Ukraine on energy and commodity prices. Those measures strip out whatever is volatile at the time.
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%.
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.”
At the time, the governor said the bank would be taking each decision based on the information available at the time.
He will deliver an economic progress report before the Calgary Chamber of Commerce on Thursday, with his remarks scheduled to be released at 1355 EDT (1735). He will hold a news conference at 1530 EDT (1930 GMT).
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Contact this reporter: max@macenews.com
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