–BOC Governing Council Still Believes Interest Rates Need to Rise Further
–BOC: Canadian Economy in Excess Demand, Labor Markets Tight
–Governor Macklem: Getting Closer to End of Tightening but Not Over Yet
–Macklem: Future Tightening Could Mean Large or Normal Rate Hike
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday raised its policy interest rate –the target for overnight lending rates — by 50 basis points to 3.75% in a sixth consecutive hike in the tightening phase that began in March, following remarks by the governor earlier this month that the economy needs more interest rate hikes as demand exceeds supply and inflation is still too high.
The size of the increase was below market expectations of 75 basis points as the bank sees its tightening campaign has produced some intended effects.
“The effects of recent policy rate increases by the bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softening,” the bank said in its policy statement.
At the same time, a rate hike by 50 basis points is still regarded by Governor Tiff Macklem as “a bigger-than-normal step.”
“Coming into this meeting, interest rates were already considerably higher,” he told a news conference after the rate decision. “Combined with the fact that there are now clear signs of the economy is slowing, we judged that it was appropriate to slow the pace of increase in our policy rates from very big steps to a big step.”
“Looking forward, we also indicated that we expect interest rates will need to rise further, so that suggests that there could be another larger-than-normal step or we may be able to move to more normal, smaller steps,” he said.
“We are getting closer to the end of this tightening phase, but we are not there yet,” he said.
BOC Still Sees Need to Raise Key Rate
It its statement issued on Wednesday, the bank said, “Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Governing Council expects that the policy interest rate will need to rise further.” It is largely the same message it sent in September: “Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further.”
The bank is expected to raise the policy rate again at its next policy meeting on Dec. 7, but its pace will depend on how things evolve. Some economists expect a 25-basis point hike each in December and January, taking the policy rate to 4.25%.
“Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding,” the bank said.
Governor Macklem didn’t have a direct answer as to whether the bank may pause in tightening at its next meeting.
Quantitative tightening that began in late April is “complementing increases in the policy rate,” the bank said, repeating its recent statement on unwinding emergency asset purchases that were aimed at reinforcing the effects of monetary easing during the early stage 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.
The bank also repeated its recent mantra by concluding its latest policy statement, “The Governing Council remains resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target.”
Front-Loading Rate Hikes
The bank has been front-loading credit tightening to prevent high inflation from becoming entrenched, which would make it harder for the bank to bring it down without causing recession. The phase of front-loading may be coming to an end as the bank’s policy rate, now at 3.75%, stands well above its latest estimate for the nominal neutral interest rate in a range of 2% to 3%, but Governor Macklem warns that Canada’s inflation is also affected by international events.
Today’s move followed five rate hikes totaling 300 basis points in the current tightening cycle, by 75 bps to 3.25% in September and 100 bps to 2.5% in July, which was the biggest increase since 1998. Earlier, the bank conducted a 50-basis point increase each in June and April and a 25-basis point rise in March, when it began the current tightening cycle with its first interest rate hike since October 2018 by lifting the key rate to 0.5% from its record low 0.25%.
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.
BOC Revises Down CPI Forecasts, Sees Slower Growth
“As the economy responds to higher interest rates and as the effects of elevated commodity prices and supply disruptions fade, the bank expects inflation to fall to about 3% in late 2023, then return to 2% in 2024,” it said.
The bank revised down its consumer inflation outlook for 2022 to 6.9% from 7.2% projected in its previous report issued in July, but it is still above 5.3% forecast in April and 4.2% forecast in January. The consumer price index rose 3.4% in 2021.
The bank also lowered its CPI forecast for 2023 to 4.1% from 4.6% projected in July, 2.8% in April and 2.3% in January.
As for the CPI in 2024, the bank forecast the annual inflation rate will come closer to its 2% target, at 2.2%, compared to 2.3% forecast three months ago and 2.2% projected six months ago.
“The Canadian economy continues to operate with significant excess demand. Businesses are facing widespread labour shortages and continuing tight labour markets,” the bank said in the report.
Looking ahead, it projected, “The pace of economic growth in Canada is slowing and is expected to moderate further. Growth is projected to essentially stall later this year and through the first half of 2023.”
Against the backdrop of rising borrowing costs, the bank revised down its 2022 economic growth forecast slightly to 3.3% from 3.5% in July and 4.2% in April, following a robust 4.5% gain in 2021. It halved its 2023 GDP growth forecast to 0.9% from 1.8% projected in July, when it slashed its forecast from 3.2% in April.
The bank expects the domestic economy to grow 2.0% in 2024, revised down from 2.4% projected in July and 2.2% in April.
Canada’s gross domestic product grew unexpectedly in July, up 0.1% on the month, but Statistic Canada’s early estimate for August is a flat reading. The economy may still post modest growth in the July-September quarter after growing a solid 0.8% on quarter, or an annualized 3.3%, in April-June, led by business investment and consumer spending on services.
Inflation Still Too High
“Inflation is broad-based, with almost two-thirds of the components of the consumer price index (CPI) showing price increases of greater than 5% over the past year,” the bank said in the report.
“However, due to falling gasoline prices, inflation has been declining from its 8.1% peak in June,” it said. “Prices for agricultural products have also tapered off, as have the inflationary pressures from global supply bottlenecks. These forces are expected to pass through to lower food and goods price inflation in the months ahead.”
The annual consumer inflation rate in Canada has slowed to 6.9% in September from a recent peak of 8.1% in June in total CPI, which is “helpful” and “welcome,” Macklem told reporters after a speech in Halifax on Oct. 6, but added, “The next thing that we are looking for is clear evidence of a more fundamental shift in underlying inflation.”
“We don’t want to overcool the economy but we really want to make sure that we keep inflation expectations anchored and we bring inflation back to target,” he said at the time. “High inflation is harming all Canadians and we need to eliminate it.”
Upside Risks to Inflation Outlook Greater
In the latest Monetary Policy Report, the bank sees both upside and downside risks to the outlook for inflation, but while it views the risks “as roughly balanced,” it also noted that “the upside risk is of greater concern because inflation is persistently high.”
On the upside, inflation may remain higher for longer than anticipated in the base case, the bank said. “One way this could occur is if inflation expectations do not adjust downward as expected,” it said. “In this case, the wage-price spiral risk scenario described in the July Report could be realized. Other factors could also lead to stickier inflation than projected in the base case.”
On the downside, the slowdown in the global economy could be even more severe and inflation would fall further than projected, the bank said.
Financial Vulnerability Amid Global Tightening
In the report, the bank also warned that as central banks in many countries raise their policy rates to address inflationary pressures, abrupt movements in risky asset prices and increased liquidity needs could occur.
“Financial vulnerabilities that have been building for some time – including high indebtedness and stretched asset valuations – could magnify the impact of global tightening,” it said. “Moreover, a higher U.S. dollar could amplify funding problems faced by some EMEs (emerging market economies) that have borrowed extensively in that currency.”
Path to Soft-Landing Has Narrowed but No Recession Forecast
Macklem told reporters that the path to soft landing of the Canadian economy has narrowed.
“We are expecting roughly zero growth for the next several quarters, and to be more specific, the last quarter of this year and the first half of next year. After that we expect growth will pick up,” he said. “We could see some contraction in GDP. We could see very modest growth in GDP. We don’t expect severe contraction.”
The governor has said the best chance of achieving soft landing is to front-load interest rate hikes, which should help guide demand move into better balance and inflation to slow. Whether Canada can achieve soft-landing and avoid recession will depend on how quickly or slowly global and domestic supply disruptions get resolved, how sticky inflation is Canada and how well-anchored domestic inflation expectations stay on target, he said.