–BOC: Ukraine War, China’s Covid Lockdowns, Supply Constraints Weighing on Growth, Boosting Inflation
–BOC Repeats: Timing, Pace of Further Rate Hikes Set by Economic Assessment
By Max Sato
(MaceNews) – The Bank of Canada on Wednesday lifted its policy interest rate – the target for overnight lending rates – by another 50 basis points to 1.5%, as expected, after raising it by 50 basis points to 1% in April, in a bid to bring decades-high inflation back to target while the economy is showing some resilience to supply constraints and the drag from Covid restrictions.
The bank also argued for the need to tighten further. “With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the Governing Council continues to judge that interest rates will need to rise further,” it said in a statement.
To Act More Forcefully If Needed
The bank also noted that the world is facing the difficult task of taming inflation while ensuring economic growth is not losing too much momentum: “The Russian invasion of Ukraine, China’s COVID-related lockdowns, and ongoing supply disruptions are all weighing on activity and boosting inflation.”
The third consecutive rate hike follows data released Tuesday that Canada’s gross domestic product grew 0.8% on quarter, or an annualized 3.1%, in the January-March period, led by business investment and consumer spending. It was in line with the BOC’s forecast of 3.0% provided in April.
The pace of growth moderated from 1.6% (6.7% annualized) in October-December in light of slower external demand, but it is still better than the first-quarter annualized GDP contraction in the US (down 1.5%) and Japan (down 1.0%) and slower growth in the Eurozone (up 0.3% on quarter).
The bank is well into its process of normalizing monetary policy after starting its credit tightening cycle in March by conducting its first interest rate hike since October 2018 and lifting the key rate to 0.5% from its record low 0.25%. There was no policy announcement in May.
With another 25-basis-point rate hike, it would finish unwinding 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.
July Rate Hike Expected
Economists expect the bank to raise the policy rate by another 50 basis points to 2% — at the low end of what it considers a level neutral to economic activity — in the next policy decision on July 13, when it also issues its quarterly Monetary Policy Report with updated growth and inflation forecasts. Economists are also pointing to the possibility of a 75-basis-point rate hike in July if data shows a continued rise in the inflation rate.
Canada’s economic activity is “strong,” the bank said.
“Job vacancies are elevated, companies are reporting widespread labour shortages, and wage growth has been picking up and broadening across sectors,” it said. “Housing market activity is moderating from exceptionally high levels. With consumer spending in Canada remaining robust and exports anticipated to strengthen, growth in the second quarter is expected to be solid.”
The Canadian economic growth in the April-June quarter may fall short of the BOC’s latest estimate of 6.0% annualized but high inflation remains the top concern for the bank.
BOC Sees Higher Risk of Stubborn Inflation
“As pervasive input price pressures feed through into consumer prices, inflation continues to broaden, with core measures of inflation ranging between 3.2% and 5.1%,” the bank warned on Wednesday. “Almost 70% of CPI categories now show inflation above 3%. The risk of elevated inflation becoming entrenched has risen.”
This assessment shows the bank is more concerned than in April, when it said: “There is an increasing risk that expectations of elevated inflation could become entrenched.”
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.
Policy Rate Nearing Neutral Level
BOC policymakers have been saying the bank has to raise interest rates to a level that is more neural 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.
Governor Tiff Macklem told a news conference in April that the bank may pause raising rates before the policy rate reaches the neutral level if the economy swiftly responds to credit tightening. But he also said the bank may continue taking the key rate above the neutral level if consumer inflation proves to be stubborn, undermining the purchasing power of households.
In its April Monetary Policy Report, the bank estimated that the nominal neutral rate in Canada currently lies in a range of 2% to 3%, 25 basis points higher than in the April 2021 assessment.
In the report, the bank revised its consumer inflation outlook for 2022 sharply to 5.3% from 4.2% projected in its previous report issued in January, accelerating from 3.4% in 2021, while raising its CPI forecast for 2023 to 2.8% from 2.3%. In its first estimate for Canada’s CPI in 2024, the bank forecast an annual rate of 2.2%, close to its 2% target.
The bank projected in April that inflation in Canada would average almost 6% in the first half of 2022 and remain well above the control range throughout this year before easing to about 2.5% in the second half of 2023 and return to the 2% target in 2024, the bank said.
At the time of the April report, the latest data showed the total CPI annual rate stood at 5.7% (4.7% excluding gasoline) in February, but since then it has moved up further to 6.7% (5.5%) in March and 6.8% (5.8%) in April. The bank projected at the time that the all-inclusive CPI would rise 5.6% on year in the first quarter and 5.8% in the second quarter. Average hourly wages for employees rose 3.3% from a year earlier in April, meaning that, on average, prices rose faster than wages, and Canadians experienced a decline in purchasing power.
In its April report, the bank revised up its 2022 economic growth forecast slightly to 4.2% from its January projection of 4.0%, following a robust 4.6% gain in 2021, but revised down its 2023 GDP growth forecast to 3.2% from 3.5% amid uncertainty. It expects the domestic economy to slow to 2.2% in 2024.