–Governing Council Still Concerned About Inflationary Risks, Particularly Persistent Underlying Price Pressures
–Some Signs that Wage Pressures in Canada Are Easing
–Governor Macklem: Too Early to Consider a Rate Cut; Clear Consensus Time is Not Now
By Max Sato
The bank said it is also continuing its policy of quantitative tightening to trim the bank’s balance sheet to a normal level.
Governing Council is “still concerned about risks to the outlook for inflation, particularly the persistence in underlying inflation,” the bank said, repeating its previous policy statement issued in January. “Governing Council wants to see further and sustained easing in core inflation and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour.”
In an encouraging sign for its inflation fight, the bank said Canadian employment continues to grow more slowly than the population, and that “there are now some signs that wage pressures may be easing” as the pace of economic growth in the fourth quarter “remained weak and below potential.”
“Overall, the data point to an economy in modest excess supply,” the bank said.
The bank’s concern is that underlying inflationary pressures persist: year-over-year and three-month measures of core inflation are in the 3% to 3.5% range, and the share of CPI components growing above 3% declined but is still above the historical average.
“The Bank continues to expect inflation to remain close to 3% during the first half of this year before gradually easing,” the BoC said.
“Monetary policy is working — inflation is coming down.” he said. “But it’s too early to loosen the restrictive policy that has gotten us this far. Low, stable inflation is a cornerstone of shared prosperity, and we remain resolute in our commitment to restore price stability.”
Economists expect the bank will wait until mid-2024 before considering lowering interest rates. The BoC will next announce its policy decision on April 10, when it also provides its medium-term economic forecasts and risk analysis in the quarterly Monetary Policy Report. In its January report, the bank projected that inflation would remain close to 3% during the first half of this year before gradually easing, returning to the 2% target in 2025.
No Forward Guidance, Taking One Meeting at a Time
Macklem told reporters that the bank does not provide forward guidance and thus that it would not put a rate cut schedule on the calendar. He called for patience: Monetary policy takes time to have a full impact on economic activity as it works through an indirect channel.
“We want to give Canadians as much information as we have but we also don’t want to give sense of false precision,” he said. “Right now, we in a difficult phase of our monetary cycle.”
“We are taking one meeting at a time,” he said, repeating his earlier remarks. “There is clear consensus at Governing Council that the time (a rate cut) is not now … and hold the policy rate at 5%.”
In January, the bank softened its hawkish stance, indicating that its confidence had increased that its policy rate was high enough to restore price stability. While the bank could not rule out the need to raise rates further if there were new inflation surprises, it indicated that its discussions were shifting from whether its policy rate is restrictive enough to restore price stability, to how long it needs to stay at the current level.
“Today’s decision reflects Governing Council’s assessment that a policy rate of 5% remains appropriate,” Macklem said. “It’s still too early to consider lowering the policy interest rate.”
Underlying Inflation Remains Sticky
Macklem said the key to the bank’s next policy change rests on developments in underlying inflation, which reflects a whole range of indicators.
“Shelter price inflation is the biggest contributor to inflation right now and it is certainly weighing on our decision,” Macklem said. “Having said that, our target is for total CPI inflation. If you look beyond shelter, we are seeing underlying inflation pressures persist.” CPI shelter items include rent, mortgage interest cost, maintenance and repairs and utilities.
The core CPI measures that strip out most of the shelter components are still running above 3%, whether on a 12- or three-month basis, he said. The year-over-year increase in the CPI trim eased to 3.4% in January from 3.7% while the annual rate of the CPI median slowed to 3.3% from 3.5%.
To assess underlying inflation, BoC officials are monitoring the core CPI, alternative CPI measures, such as excluding energy prices, the percentage of CPI components that are rising faster than 3% (still at 45%, double a usual range of 20% to 25% when inflation is at 2%), wage growth, balance between supply and demand, inflation expectations and corporate pricing behavior.
No Change to Quantitative Tightening Schedule
Macklem said the bank conducted 13 repo market operations worth C$5 billion in January to relieve upward pressures on the overnight interest rate that moved above the 5% target, and hasn’t done any since, indicating the pressure has gone away.
“We don’t think QT (quantitative tightening) was the root cause of these overnight pressures,” he said. “You shouldn’t take this tightening that we saw in January as a suggestion or a sign that QT is likely to end earlier that we previously expected (sometime in late 2024 or early 2025).”
Senior Deputy Governor Carolyn Rogers said the bank’s balance sheet is about 40% smaller than when QT started in April 2022 and that the bank will give advance notice if the strategy on QT is going to change. Through QT, the bank allows its holdings of Government of Canada bonds to mature and stops reinvesting the proceeds of principal and coupon repayments.
Asked about an upside risk to the bank’s inflation forecast, Macklem said there are global risks, but so far the impact of attacks on ships in the Red Sea and water shortage at Panama Canal on transportation costs “has not been very large.” Domestically, the upside risk is that lower but sticky underlying inflation stalls and does not come down to 2%.
Rogers said the bank is closely watching developments in the commercial real-estate market but noted that the Canadian banking sector’s exposure to the market is spread more broadly compared to the U.S. where it is mostly held by mid-tier banks.
Asked whether what can be seen as an asset bubble in record high stock market prices in some economies including the U.S. and Japan would make the BoC’s policy decisions more challenging, Rogers said, “We watch generally financial conditions .… It does look to be some exuberance in equities.” The bank does not forecast stock prices, she said, but added, “I think in general what the markets are doing is the same thing what you are doing here today — trying to understand when we will see a pivot to lower rates, so we will continue to monitor it.”
The BoC raised its target for overnight lending rates by a total of 475 basis points (4.75 percentage points) between March 2022 and July 2023, jacking up the key rate through 10 increases from its record low of 0.25% to a 22-year high of 5%.