–-BOC: Members Saw Two Factors Keeping Inflation Above Target: Tightening Taking Longer Than Usual to Have Impact, Demand May Be Stronger Than Expected
By Max Sato
(MaceNews) – Bank of Canada policymakers discussed whether to raise the policy rate in July or wait for more evidence to solidify the case for further tightening and reached consensus that “the cost of delaying action was larger than the benefit of waiting,” according to the summary of deliberations at the bank’s July 12 meeting released Wednesday.
During the discussion, the bank’s Governing Council members agreed that inflation remains above target despite rounds of rate hikes because two different forces may be at play: It is taking longer than usual for credit tightening to slow economic activity and demand may be stronger than expected.
“With inflation projected to be around 3% for the next year and with the upside risks to inflation expectations and household spending, Governing Council members were concerned that the progress toward price stability could stall, and inflation could even rise again if upside surprises materialize,” the summary said.
At the July meeting, the bank raised its policy interest rate – the target for overnight lending rates – by another 25 basis points to a fresh 22-year high of 5.00% from 4.75% during the current tightening cycle that began March last year aimed at bringing elevated inflation back to target.
The move was widely expected and followed a surprise 25-basis point rate hike last month and a “conditional” pause in April and March. In January, the bank raised the policy rate for the eighth consecutive time with a 25-basis point hike, slowing the pace from 50 bps in December and October, 75 bps in September and 100 bps in July last year.
Members discussed how to characterize the likely future path for interest rates in their communications.
“They agreed that, given the uncertainties around the forecast and the size and timing of the impact of higher interest rates on demand, they would approach future decisions one at a time based on the available evidence,” the summary said. “They agreed they were prepared to raise the policy rate further if inflationary pressures did not ease as projected and progress toward the 2%target stalled. But they did not want to do more than they had to.”
Governing Council agreed to continue to assess whether the following indicators evolve in a direction that is consistent with achieving the inflation target: the evolution of excess demand, inflation expectations, wage growth and
corporate pricing behaviour.
Governing Council members discussed how best to balance the risks of under- and over-tightening.
If policy is not restrictive enough to bring inflation to target on a reasonable timetable, there is a risk that rates will have to be increased by even more later, the summary said. But if policy is simply taking longer to work because the lagged effects of nominal tightening are only recently starting to have an impact on overall consumption, over-tightening risks making economic conditions more painful than necessary, it said.
“In assessing the risks, Governing Council members took on board some elements of both scenarios,” the summary said.
“In particular, they agreed that past increases in interest rates would continue to feed through the economy, slowing demand,” it said. “ At the same time, they agreed that both excess demand and underlying inflation were looking more persistent.”
BOC policymakers also agreed that while long-run inflation expectations still looked reasonably anchored, with inflation projected to be above target for another year, “they needed to be alive to the risk that near-term inflation expectations could remain high, making it harder to restore price stability.”
By the July 12 meeting, the annual consumer inflation rate in Canada had eased to 3.4% in May from 4.4% in April, hitting the lowest since 3.1% in June 2021 due mainly to lower energy costs in a base-year effect.
The June CPI data, released the following week, showed that the year-on-year increase in the total consumer price index slowed further to 2.8% but it is still above the bank’s 2% target.