–Governing Council Concerned Inflationary Risks Have Increased, Prepared to Raise Policy Rate Further if needed
–Governor Macklem: ‘We Are Keeping the Door Open for a Further Interest Rate Increase Because There Is Uncertainty’
–Macklem: Path to Soft Landing Has Gotten Narrower
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday maintained its policy interest rate — the target for overnight lending rates — at a 22-year high of 5.0% in the face of a dimmer business outlook and gradually easing price pressures, but left the door open for further credit tightening to bring inflation back down to its 2% target as core inflation is proving to be more stubborn than expected.
The bank said it is also continuing its policy of quantitative tightening to trim the bank’s balance sheet to a normal level.
No change in policy was widely expected following a pause in September, a 25- basis point hike each in July and June, a conditional pause in April and March and an eighth consecutive increase in January.
Comments from the central bank chief indicated that upside risks to the bank’s main forecast may come from heightened geopolitical risks and high fiscal spending plans.
“Inflation has come down a lot since the summer of 2022, but as every Canadian knows, inflation is still too high,” Governor Tiff Macklem told a news conference. “
“We held our policy rate steady today because monetary policy is working to cool the economy and relieve price pressures, and we want to give it time to do its job,” he said. “But further easing in inflation is likely to be slow, and inflationary risks have increased.”
Macklem repeated his recent remarks that the bank’s policymakers are trying to balance the risks of under- and over-tightening monetary policy. He also said last month that policy decisions were becoming difficult.
“Overall, a range of indicators suggest that supply and demand in the economy are now approaching balance,” the bank said in a statement on Wednesday.
In the bank’s October projection, CPI inflation is expected to average about 3.5% through the middle of next year before gradually easing to 2% in 2025. “Inflation returns to target about the same time as in the July projection, but the near-term path is higher because of energy prices and ongoing persistence in core inflation,” the bank said.
Policymakers Concerned About Increased Inflationary Risks; Prepared to Act If Needed
“With clearer signs that monetary policy is moderating spending and relieving price pressures, Governing Council decided to hold the policy rate at 5% and to continue to normalize the Bank’s balance sheet,” the bank said.
“However, Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed,” it said. Last month, the bank said the policy-setting panel remained concerned about the persistence of underlying inflationary pressures, and was prepared to increase the policy interest rate further if needed.
“Governing Council wants to see downward momentum in core inflation, and continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour,” the bank said, largely repeating its statements issued in September and July.
If those factors are normalized, “We probably don’t have to raise interest rates,” Macklem said. “But we’ve been very deliberate. We are leaving the door open to a further interest rate increase because there is uncertainty about that. And if we see inflationary pressures persist, we are prepared to raise our interest rate further.”
Asked about the near-term prospect for a further rate hike, he replied, “We are going to take our decision one at a time, based on the best available data and information at the time of that decision.”
Core inflation has made little progress after falling from just over 5% on year in 2022 to just under 4% in mid-2023. This is consistent with the three-month rates: CPI-trim and CPI-median have hovered mostly in the 3.5% to 4% range over the past year.
The BOC has raised its target for overnight lending rates by a total of 475 basis points (4.75 percentage points) since March 2022, jacking up the key rate through 10 increases from its record low of 0.25%.
The bank will announce its next policy decision on Dec. 6.
Rate Hikes Not Leading to Stronger Canadian Dollar
Macklem said the Canadian dollar has been “reasonably stable,” down a little bit against the U.S. dollar and up against most other currencies. Higher interest rates tend to lead the country’s currency to appreciate but since other major central banks have also raised their policy rates higher, the current tightening cycle has not produced notable effects of cooling inflation from the currency side.
A series of rate hikes by the Federal Reserve is “restraining demand for Canadian exports,” which should help ease domestic inflation, but Canada is not receiving the direct impact of its stable currency to lower import inflation, the governor said.
“Everything else equal, we have to rely more on interest rates,” he said. “We don’t target the exchange rate. We take it into account. It’s determined by market factors.”
Canadian Economy Slowing but Not In Recession; Narrower Path to Soft-Landing
“Growing evidence shows that past interest rate increases are working to bring
demand and supply back into balance,” the bank said. “GDP growth has averaged
1% over the past year, lower than the rate of potential output growth.”
Macklem described the below 1% GDP projected by the bank as “low positive growth” and “not a recession” but he also said he could not rule out small negative figures.
“We’ve been saying that the path to soft-landing is narrow,” he said. “In this projection, that path has gotten narrower.”
The governor denied that the economy is in stagflation, a combination of high inflation and high unemployment. He noted that inflation just below 4% is much lower than the average 8% in the 1970s and that the 5.5% unemployment rate is below Canada’s historical norms.
The economy made a weak start to the third quarter, with the GDP showing flat growth on quarter in July after falling 0.2% in June. In its advance estimate, Statistics Canada sees the GDP edged up 0.1% in August.
Contrary to the bank’s 1.5% growth forecast, the Canadian economy contracted in April-June, being flat (-0.0%) on quarter, or falling an annualized 0.2%, as household spending lost some steam after surging in the previous quarter. It was also due to a decline in housing activity and the drag from wildfires in many regions of the country.
For the whole year, the bank revised down its 2023 GDP growth forecast to 1.2% from 1.8% projected in July while revising down its 2024 growth forecast to 0.9% from 1.2%. The bank forecast Canada’s economic growth will pick up to 2.5% in 2025, revised up slightly from its estimate of 2.4% made about three months ago.
The bank’s near-term forecast for the U.S. economy is higher 2.2% growth for 2023, revised up from 1.8% in July. The governor explained that Canadian home owners are hit harder by higher borrowing costs as their mortgages are renewed every three years, instead of 30 years in the U.S., and that for this reason, Canadians consumers are setting aside more funds from their extra savings built during the pandemic while their U.S. counterparts are spending.
Inflationary Pressures Seen Up in 2023, 2024
The bank’s latest consumer inflation outlook for 2023 is 3.9%, up from 3.7% projected in July. The consumer price index surged 6.8% in 2022 after a 3.4% rise in 2021.
As for the CPI in 2024, the bank forecast the annual inflation rate will remain high at 3.0%, revised up from 2.5% projected in July and still above its 2% target. The bank’s CPI estimate for 2025 is 2.2%, little changed from 2.1% projected three months ago.
CPI inflation has fluctuated between 2.8% and 4.0% after having dropped significantly from its peak of 8.1% in June 2022. “Although price pressures are easing for some goods and services, core inflation is proving to be more stubborn than anticipated,” the bank said in the October report.
Inflationary Pressures from Fiscal Spending
On the impact of fiscal policy on sticky inflation, Macklem said government spending over the past year has been below 2%, Canada’s potential output, which means it is not adding undue inflationary pressures.
But for 2024, the bank estimates that combined spending by the federal and provincial governments would grow 2.5%, he said, adding, “In an environment where we are trying to moderate spending and get inflation down, that’s not helpful.”
“It would be helpful if the governments considered the inflationary impact of their spending decisions,” Macklem said. “It’s going to be easier to get inflation down if monetary and fiscal policy are rowing in the same direction.
Middle East War Adds to Upside Risk to Inflation Forecast
Among the upside risks to the bank’s main inflation scenario is heightened geopolitical risks, although part of the oil price increase has been built into the bank’s projection. The war in Israel and Gaza has not impacted the supply of crude oil but if it were to spread further into a broader regional conflict, global oil supplies could be disrupted and oil prices would rise amid low inventories, the report said.
“If such a rise in oil prices materializes and is sustained, pass-through to
other prices may occur,” the bank warned. “Inflation could climb sharply, particularly in a context in which businesses change prices frequently. Heightened geopolitical uncertainties may also create new cost pressures by affecting the global supply chains for goods and raw materials.”
The governor said the bank’s policymakers need to be more cautious than normal about seeing through the impact on core inflation.
“If we saw evidence that higher energy prices were passing through to broader prices, higher transportation costs for example. That would be a signal that the increase in oil prices is starting to feed through to the rest of the economy. That would be really something of concern to us.”
Downside risks would come from a faster-than-expected slowdown in the Canadian economy if the effects of domestic and global credit tightening proved to be larger than anticipated.
Macklem said the impact of the heightened geopolitical risks on consumer spending patterns is hard to assess and needs to be closely watched.