–BOC: Key Rate Still Needs to Rise Further, to See How Much Higher It Should Go
–BOC Repeats: Canadian Economy in Excess Demand, Inflation High and Broad
–BOC: Economy to Moderate in 2nd Half of 2022 on Slower Global Demand, Tightening
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday raised its policy interest rate — the target for overnight lending rates — by 75 basis points to 3.25%, as widely expected, as part of its front-loading credit tightening drive to bring down four decade-high inflation.
The bank also stressed that its policymaking panel believes it will need to raise the policy rate further in the face of broadening price pressures and strong domestic demand.
Today’s move followed a rate hike by an unusually large 100 basis points in July for the biggest increase since 1998. At the time, Governor Tiff Macklem said the aggressive tightening reflected “very unusual economic circumstances” of inflation nearly at 8% and stressed that the key rate must rise further to around the top end of the 2% to 3% neutral range.
The bank has now raised the policy rate for the fifth consecutive time totaling 300 basis points and BOC policymakers have said their job is not done yet, possibly following up with another rate hike, by 25 or 50 basis points, in the bank’s next policy decision on Oct. 26. The last policy meeting scheduled for the year is on Dec. 7.
BOC Still Sees Need to Raise Key Rate
It its statement issued on Wednesday, the bank said, “Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further.”
Quantitative tightening that began in late April is “complementing increases in the policy rate,” it said, repeating its recent statement.
The bank also indicated tightening may be coming to an end soon during the current cycle by saying, “As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target.”
This compares with the bank’s July statement: “The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the bank’s ongoing assessment of the economy and inflation.”
The bank 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.”
Earlier, the bank conducted a 50-basis point increase 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%.
In June, the bank warned that it was “prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target,” setting the stage for the 100 basis point hike in July.
Inflation Still Too High
The annual consumer inflation rate in Canada has slowed to 7.6% in July from 8.1% in June due to a smaller year-on-year rise in gasoline prices. Excluding gasoline, the CPI rose 6.6% on year in July, up slightly from a 6.5% gain in June, as upward pressure on prices remained broad-based.
The bank noted that “inflation excluding gasoline increased and data indicate a further broadening of price pressures, particularly in services” and its core measures of inflation continued to move up, ranging from 5% to 5.5% in July.
“Surveys suggest that short-term inflation expectations remain high. The longer this continues, the greater the risk that elevated inflation becomes entrenched,” the bank said.
In a post-policy decision briefing in July, the governor said the bank was increasing its policy interest rate quickly “to prevent high inflation from becoming entrenched.”
“By front-loading interest rate increases now, we are trying to avoid the need for even higher interest rates down the road,” the governor said at the time, adding that “the path to soft-landing is narrow.”
Strong Domestic Demand
The latest data showed that Canada’s gross domestic product grew 0.8% on quarter, or 3.3% at an annualized rate, in the April-June quarter, coming in weaker than expected but still stronger than the U.S. economy, which posted the second straight contraction in the second quarter.
“The Canadian economy continues to operate in excess demand and labour markets remain tight,” the bank said, repeating its recent assessment.
While the second quarter GDP growth was “somewhat weaker than the bank had projected, indicators of domestic demand were very strong — consumption grew by about 9.5% and business investment was up by close to 12%.”
The bank said the economy is showing some intended effects of its aggressive tightening.
“With higher mortgage rates, the housing market is pulling back as anticipated, following unsustainable growth during the pandemic,” it said. “The bank continues to expect the economy to moderate in the second half of this year, as global demand weakens and tighter monetary policy here in Canada begins to bring demand more in line with supply.”
Official data showed the growth in Canada was led by private consumption spurred by pent-up demand for travel and entertainment while rising mortgage rates dampened housing construction. In June, GDP rose 0.1% on the month and Statistics Canada’s early estimate for July is a slight 0.1% pullback.
Policy Rate Above Neutral Range
The bank’s policy rate, now at 3.25%, stands just above its latest estimate for the nominal neutral interest rate in a range of 2% to 3%.
BOC policymakers have been saying the bank has to raise interest rates to a level that is more neutral to economic activity, adding that Canadian households and businesses can withstand higher borrowing costs. They also expect rate hikes will lead the overheated Canadian housing market to moderate over time from an extremely elevated level to a still high level, and that this process would not kill the economy.
As for asset purchases aimed at reinforcing the effects of monetary easing, the bank’s Governing Council decided on April 13 to begin the process of quantitative tightening, effective April 25. It has stopped reinvesting in government bonds and let its swollen balance sheet shrink in line with economic recovery from the pandemic-caused slump.
As an emergency measure, the bank began buying government debt in March 2020 to provide liquidity and ease market strains. In July that year, it formally called the program “quantitative easing (QE),” using the tool to support the economy by keeping market interest rates low.
With its hike in July, the bank had already 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.