By Max Sato
(MaceNews) – The Bank of Canada is widely expected to top up its surprise June rate hike on Wednesday, taking the policy interest rate to a fresh 22-year high, but it remains uncertain whether the bank is done with 16 months of credit tightening aimed at guiding inflation lower to its 2% target, and whether the cumulative effects of its rates hikes may trigger a recession.
Most economists expect the bank to raise its policy interest rate – the target for overnight lending rates – by another 25 basis points to 5.00%, the highest since April 2001, after raising it by 25 basis points to 4.75% last month and taking a “conditional” pause for a second straight meeting in April. There is some caution about a slight possibility of the bank standing pat.
With the June rate hike, the bank had tightened rates by a total of 450 basis points (4.50 percentage points), jacking up the key rate through nine increases from its record low of 0.25%.
The focus is on how the bank’s Governing Council will describe the tightness of money available to households and businesses in its policy statement on Wednesday.
In the last rate announcement on June 7, the bank said its policymaking panel decided to increase the policy interest rate “reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target.”
The bank said last month that the domestic labor market remained tight and economic growth had been resilient despite higher borrowing costs. Higher immigration and participation rates were expanding the supply of workers but new workers had been quickly hired, reflecting continued strong demand for labour, it said.
The focus is also on the bank’s assessment of inflation. Since the June meeting, the annual consumer inflation rate has eased to 3.4% in the latest data for May from 4.4% in April, hitting the lowest since 3.1% in June 2021 due mainly to lower energy costs in a base-year effect.
In June, the bank’s policymakers said they would be particularly “evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the inflation target.”
The bank warned at the time that, with three-month measures of core inflation running in the 3.5% to 4% range for several months and excess demand persisting, “concerns have increased that CPI inflation could get stuck materially above the 2% target.”
In the latest Labour Force Survey, which was released on Friday, Canadian employment surged by 59,900 in June, beating expectations and all coming from full-time jobs, while average hourly wages rose 4.2% on the year in June, slowing sharply from a 5.1% rise in May.
The unemployment rate rose to 5.4% in June from 5.2% in May as more people looked for work, rising further from 5.0% seen in the previous five months and a recent low of 4.9% recorded in June and July 2022.
It is a clear recession signal if the three-month moving average on the jobless rate rises 0.5 percentage point from the low of the past year, said Douglas Porter, chief economist at BMO Financial Group. In Canada, the three-month moving average is 5.2%, which is up 0.3 point from the low, but it will be up 0.5 point if June’s rate holds in the summer, he said.
“There have been episodes where a move similar to the 0.5 percentage point
rise in the past year have not translated to a full-blown recession, but they were near-misses, in 1995 and 2001,” he said.
On the possibility of recession, Porter said, “We have been calling for a mild contraction for almost a year now, and it has yet to happen. We keep pushing the recession call back and we are not alone.”
The Bank of Canada will update its economic forecasts in the quarterly Monetary Policy Report also due on Wednesday.
In its April report, the bank raised its 2023 GDP growth forecast to 1.4% from 1.0% projected in January while revising down its 2024 growth forecast to 1.3% from 1.8%. In its first estimate, the bank forecast Canada’s economic growth will pick up to 2.5% in 2025.
In the April MPR, the bank’s consumer inflation outlook for 2023 was 3.5%, little changed from 3.6% projected in January. The consumer price index jumped 6.8% in 2022 after a 3.4% rise in 2021. As for the CPI in 2024, the bank forecast the annual inflation rate would drift down to 2.3%, just above its 2% target and unchanged from its January projection. The bank’s CPI estimate for 2025 was 2.1%.
Canada’s gross domestic product grew an annualized 3.1% in the January-March period on relatively mild winter and resilient consumer spending, rebounding from a 0.1% contraction in the final quarter of 2022. It was above the early estimate of 2.5% and the BOC’s 2.3% forecast made in April. It is also the highest growth for the quarter among the Group of Seven major economies.
The GDP was flat on the month in April but Statistics Canada’s advance estimate for May is a 0.4% jump, led by growth in the manufacturing and wholesale trade sectors as well as offices of real estate agents and brokers.
In the summary of deliberations leading to the June 7 rate hike released on June 21, the bank said, “Governing Council agreed that the economy remained clearly in excess demand and that the rebalancing of supply and demand was likely to take longer than previously expected.”
“More recent data, particularly the increase in housing resales, suggested additional momentum in household sector demand. Growth in the second quarter was therefore viewed as likely to be stronger than forecast in the April MPR,” it said.
Even though mortgage rates and other borrowing costs have been rising, households are slightly less sensitive to rate hikes than expected, Bank of Canada Deputy Governor Paul Beaudry told reporters on June 8.
“On housing, I think it is possible to pull down core (inflation) with a still-healthy housing market,” BMO’s Porter said. “Housing has not played a big direct role in driving inflation, although the two are not unrelated, and there have been periods in the past when housing was booming and inflation was calm, for example in 2016 and 2017.”
Critics are calling on Canadian government at all levels to take more action to help increase housing supply to middle to lower income earners and curb speculative investment in properties in order to fundamentally cool off the housing market.