–BOC Decision Reflects Its View: Policy Not Sufficiently Restrictive to Bring Supply/Demand Back into Balance, Return Inflation Sustainably To 2% Target
–BOC: Canada’s Labor Market Remains Tight; Overall, Excess Demand Looks to Be More Persistent Than Anticipated
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday raised its policy interest rate – the target for overnight lending rates – by 25 basis points to 4.75% from 4.50% after pausing for a second straight meeting in April during the current tightening cycle that began in March last year.
Wednesday’s rate move surprised most market participants who had anticipated no action in June and a hike by 25 basis points in July. Governor Tiff Macklem had repeatedly said that it was a “conditional pause” and that the bank would be prepared to raise rates further if it believed it was necessary to do so to get inflation back to target.
The bank has now tightened rates by a total of 450 basis points (4.50 percentage points), jacking up the key rate through nine increases from its record low of 0.25%.
The domestic labor market remains tight and economic growth has been resilient despite higher borrowing costs, the bank said in its policy announcement. Higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour, the bank said.
Demand for services continues to rebound while spending on interest-sensitive goods have increased and housing market activity has picked up, the statement said. Goods price inflation increased, despite lower energy costs. Services price inflation remained elevated. The annual inflation rate stands at 4.4%, above the bank’s 2% target.
To sum up the latest economic climate, the bank said, “Overall, excess demand in the economy looks to be more persistent than anticipated.”
Monetary Policy Was Not Sufficiently Restrictive
“Based on the accumulation of evidence, Governing Council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target,” the bank said.
The bank stopped saying in the statement that it remains prepared to act further if needed.
“Quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the bank’s balance sheet,” it noted.
To Watch Excess Demand, Inflation Outlook, Wages, Pricing
Looking ahead, the bank said, “Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the inflation target.”
This compares to its statement released in April: “Governing Council continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the 2% target.”
The bank largely maintained its near-term outlook that CPI inflation will “ease to around 3% in the summer (from June to August)” as lower energy prices feed through and last year’s large price gains fall out of the yearly data. In April, the bank said it expected CPI inflation to fall quickly to around 3% in the middle of this year.
BOC Warns: Inflation Could Get Stuck Above 2%
“However, with three-month measures of core inflation running in the 3.5% to 4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target,” it warned.
The bank is scheduled to announce its next monetary policy decision on July 12, when it also provides medium-term growth and inflation forecasts and risk analysis in its quarterly Monetary Policy Report.
“If the data remain firm over the coming few weeks, another 25 bp hike in July looks likely,” Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets wrote in a report. “We’ll get more details on the decision from Deputy Governor Beaudry tomorrow when he delivers the Economic Progress Report.”
Among key, the Labour Force Survey for May, due on Friday, is forecast to show employment grew 20,500 following a stronger-than-expected rise by 41,400 in April. The unemployment rate is seen edging up to 5.1% from 5.0%.
Resilient Economic Activity Amid Higher Interest Rates
Canada’s gross domestic product grew an annualized 3.1% in the January-March period on relatively mild winter and resilient consumer spending, rebounding from a 0.1% contraction in the final quarter of 2022. It was above the early estimate of 2.5% and the BOC’s 2.3% forecast made in April. It is also the highest growth for the quarter among the Group of Seven major economies.
The flash estimate for April GDP by Statistics Canada is a 0.2% increase despite the public sector strike in the second half of the month, indicating underlying momentum in the economy is solid.
Total consumer prices rose 4.4% on the year in April, ticking up from 4.3% in March for the first increase in 10 months. It is still slower than 5.2% in February and the recent peak of 8.1% recorded in June 2022.
In its April policy decision, the bank said it “expects CPI inflation to fall quickly to around 3% in the middle of this year and then decline more gradually to the 2% target by the end of 2024.”
The Bank of Canada was the first among major central banks to pause after their aggressive credit tightening last year (except for the Bank of Japan, which has been tweaking its large-scale monetary easing tools to make them more sustainable toward stable 2% inflation with substantial wage hikes).
In January this year, the bank raised the policy rate for the eighth consecutive time a 25-basis-point hike. The pace was slower than 50 bps in December and October, 75 bps in September and 100 bps in July.
The nine rate hikes in 15 months totaling 450 basis points pushed up the policy rate from its record low of 0.25%, which had been in place for two years until March 2, 2022. The current policy rate stands well above the bank’s latest estimate for the nominal neutral interest rate in a range of 2% to 3%.
The bank has more than unwound its emergency three rate cuts totaling 150 basis points conducted in March 2020 during the first wave of the global pandemic, which lowered the policy rate to 0.25% from 1.75%, a level that had been maintained for over a year since it was raised from 1.50% on Oct. 24, 2018.
Through “quantitative tightening” that began in April 2022, the bank has been unwinding emergency asset purchases that were aimed at reinforcing the effects of monetary easing during the early phase of the pandemic. The bank stopped reinvesting in government bonds and is letting its swollen balance sheet shrink in line with economic recovery from the pandemic-caused slump.