–BOC: Interest Rates Need to Rise Further, Pace Up to Economic Assessment
–BOC: Canadian Economy in Excess Demand, Inflation High and Broad
–BOC Revises Up CPI Forecasts for Next Few Years, Sees Slower GDP Growth
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday surprised the markets by jacking up its policy interest rate – the target for overnight lending rates – by 100 basis points to 2.5%, the biggest rate increase since 1998, but the governor of the central bank said the key rate must rise further to around the top end of the 2% to 3% neutral range.
The bank acted more aggressively than markets expected, above the consensus call of a 75-basis point rise. It is a fourth consecutive rate hike aimed at bringing decades-high inflation back to target while the economy is still showing some resilience to rising borrowing costs and the drag from the pandemic. Economists expect a 50- basis point hike in the bank’s next policy decision on Sept. 7.
“An increase of this magnitude at one meeting is very unusual,” Governor Tiff Macklem said in a statement. “It reflects very unusual economic circumstances: inflation is nearly 8%—a level not seen in nearly 40 years.”
The latest action followed a 50-basis point increase in each of the previous policy decisions, in June and April, and a 25-basis point rise in March, when it began the current credit tightening cycle by conducting its first interest rate hike since October 2018 and lifting the key rate to 0.5% from its record low 0.25%.
In its previous policy announcement in June, the bank warned that it “is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.” Market participants and economists interpreted it to mean that the bank was set for a 75-basis point rate increase in July.
The bank sought to justify its hawkish stand, by saying, “With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today.”
FRONT-LOADING RATE HIKES FOR ECONOMY’S SOFT-LANDING
Macklem told a news conference that the bank’s goal is “to get inflation back to its 2% target with a soft landing for the economy.”
“To accomplish that, we are increasing our policy interest rate quickly to prevent high inflation from becoming entrenched,” he said. “If it does, it will be more painful for the economy—and for Canadians—to get inflation back down.”
“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, adding that “the path to soft-landing is narrow.”
“Front-loaded tightening cycles tend to be followed by softer landings. This argues for getting our policy rate quickly to the top end or slightly above the neutral range,” he said.
Policy Rate Now in Neutral Range
The bank’s policy rate, now at 2.5%, stands at the midpoint of 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.
Bank of Canada Senior Deputy Governor Carolyn Rogers also told reporters that the housing market in Canada must cool off. “We have very elevated housing prices in Canada,” she said. The vast majority of mortgages are set at fixed rates, she said. It is believed to cushion the impact of the rate hikes for now until they are adjusted later.
As international inflationary pressures ease off, inflation in Canada should come back to target, Macklem said. He described the current domestic inflation as “increasing, broadening and persistent” due to shortages of workers and products.
BOC: Rates Need to Rise Further
In its latest statement issued on Wednesday, it said, “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.
“Quantitative tightening continues and is complementing increases in the policy interest rate. The Governing Council is resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target,” it said.
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 now 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, but 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 today’s move, 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, lowering 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 Up CPI Forecasts, Sees Slower Growth
The bank also raised its CPI forecast for 2023 to 4.6% from 2.8% projected in April and 2.3% in January. As for the CPI in 2024, the bank forecast an annual rate of 2.3%, up slightly from 2.2% forecast three months ago, but still close to its 2% inflation target.
Amid signs of slowing economic activity, the bank revised down its 2022 economic growth forecast to 3.5% in July from 4.2% in April, following a robust 4.6% gain in 2021. It also revised down its 2023 GDP growth forecast sharply to 1.8% from 3.2% amid uncertainty. It expects the domestic economy to pick up its pace of expansion to 2.4% in 2024, revised up from its 2.2% projection in April.
“Canadian economy is overheated, and labour markets are tight,” the bank said in the report. “With strong demand for their products, businesses are passing through higher input and labour costs to consumer prices.”
“With global growth moderating and higher interest rates dampening domestic spending, growth in Canada is projected to slow from 3½% in 2022 to 1¾% in 2023 and 2½% in 2024,” the bank said. “This allows supply to catch up with demand, reducing domestic inflationary pressures.”
Canada’s gross domestic product grew 0.3% on the month in April, but the Statistic Canada’s early estimate for May points to a 0.2% pullback. This indicates that GDP growth in the April-June quarter may not be so strong as previously expected, with a rebound in the service sector under eased Covid restrictions partially offset by slowing housing markets and sluggish auto production amid lingering supply bottlenecks.
The economy grew 0.8% on quarter, or an annualized 3.1%, in the January-March period, led by business investment and consumer spending.