Bank of Canada raises interest rates to 4.5% and plans to hold
The central bank is trying to fight skyrocketing inflation
The Bank of Canada raised interest rates for the eighth straight and possibly last time, and said it would step aside and assess the impact of rapid tightening on the economy.
Policymakers led by Governor Tiff Macklem on Wednesday raised the federal funds rate by 25 basis points to 4.5 percent, the highest level in 15 years.
The move was widely anticipated by economists as banks try to battle record-high inflation.
It is the eighth time in less than a year that banks have raised interest rates — a move that will make borrowing more expensive.
However, at a quarter percentage point, it was also the smallest increase since March and thus a sign that the bank is likely done raising rates for now.
The bank said so at a press conference following the announcement, with Governor Tiff Macklem using the word “pause” to describe the bank’s current monetary policy strategy.
“Given today’s modest hikes, we expect to hold off on rate hikes while we assess the impact of the significant monetary tightening that has taken place,” he said. “To be clear, this is a conditional break – it is contingent on economic developments moving forward in line with our… outlook.
“If we need to do more to bring inflation to our 2 percent target, we will do it.
Although the quarter-point increase was in line with market and economist expectations, most analysts failed to see that the central bank had explicitly stated a possible end point for a rate hike.
Yields on Canadian government bonds and the currency fell as investors digested signals from the central bank that it will keep interest rates steady.
The Loonie fell to $1.3428 per dollar after the decision before erasing those losses. The yield on Canada’s two-year Treasury bond fell to 3.57% by 2:09 PM ET, down about 8 basis points on the day. Two-year US Treasury yields briefly fell a few basis points after the news.
Inflation is now expected to slow to 3% by mid-year and return to its target of 2% in 2024. Officials say a fall in the quarterly core inflation reading could indicate underlying price pressures have peaked.
In the quarterly monetary policy report released alongside the decision, officials said the economy was still overheating. But growth is expected to slow rapidly. Higher interest rates weigh on the housing market and household spending and are likely to help slow growth and inflation.
“If broad economic developments are in line with the MPR’s outlook, the Governing Board expects to maintain interest rates at current levels,” the bank said in its rate statement.
However, policymakers warned that further gains may be needed if the economic data surprises. The bank “stands ready to raise interest rates further if necessary to bring inflation back to the 2 percent target.”
Trading in swaps suggests the market is waiting for banks’ next move to cut interest rates, possibly as early as October.
When asked about the possibility of a rate cut this year during a press conference, Macklem said it was “too early to talk about a cut.”
Carolyn Rogers, the bank’s senior deputy governor, said the bank needed to see “accumulating evidence” that economic momentum and price pressures had shifted to policymakers before raising interest rates again.
The conditional pause – the first among Group of Seven central banks – indicates officials are confident that current interest rates are tight enough to restore price stability.
Bank Of Canada Interest Rate announcement
In his opening remarks at the press conference, Macklem acknowledged that the full impact of his ascent so far “is yet to come”, given its speed and scale. Overnight rates rose from 0.25% to 4.5% in less than a year.
“We try to balance the risk of under and over-firing,” said Macklem. “If we do too little, inflation will stop falling before we get back to target.” But if we do too much, we will make adjustments that are unnecessarily painful and miss our inflation target.”
The Bank of Canada “provided some unexpected hints that this could be a peak” for interest rates, said Andrew Grantham, an economist at the Canadian Imperial Bank of Commerce, in a note to investors. He predicted this would be the last hike.
In their report, officials raised their estimate of economic growth in 2022 to 3.6 percent and forecast a 1 percent increase this year, compared to 3.3 percent and 0.9 percent in their October forecasts. They said the probability of two consecutive quarters of negative growth, a so-called technical recession, was “roughly the same” as a small expansion in 2023.
The Bank of Canada, which urged its global counterparts to raise interest rates rapidly last year, may now be formulating a plan to overcome the lull.
The global economic outlook is improving due to Europe’s resilience during the energy crisis, China’s reopening, falling commodity prices, and supply worry easing.
In Canada, it’s a mixed picture. The job market created more jobs at the end of last year. On the other hand, heavily indebted households are feeling the burden of higher interest rates and rising housing and food costs. And there is a risk that services inflation will remain high if businesses continue to struggle to find the workers they need, officials said.
For the first time in its history, the Bank of Canada will provide a public glimpse of the rate-setting process and will share minutes of its meetings with central banks such as the US Federal Reserve and the Bank of England. A brief summary of the bank’s considerations will be published on February 8.
Change of direction in politics
They weren’t the only ones who thought so either.
Stephen Brown, an economist at Capital Economics, believes Canada’s economy is slowing fast and inflation could return to the 1% to 3% range sooner than many expect.
“We continue to believe banks underestimated how quickly core prices will fall, with our forecast still indicating that core inflation will fall to 2 percent in the second half of this year,” he said.
“As a result, we remain confident that today’s rate hike will be the last, and we see an opportunity for the bank to cut rates again in the third quarter.”
After eight rate hikes in less than a year, lower rates will be welcome news for borrowers like Mahtob. But at the press conference following the tariff announcement, Macklem was repeatedly asked if there would be a tariff cut – and he always dismissed the idea.
“Let’s just say that inflation is still above 6 percent,” he said. “Inflation is down, but we must be humble; There are a number of risks… So it’s too early to talk about layoffs.”
Mortgage broker Samantha Brooks agrees the days of low-interest rates could be gone forever.
Forecasts for a sharp decline in inflation
Core inflation slowed from a peak of 8.1 percent in mid-2022 and last reached 6.3 percent in December.
The Bank of Canada said Wednesday in its latest set of forecasts that it expects inflation to “slow down significantly” in the coming months, reaching 3 percent in mid-2023 and 2 percent next year. The central bank previously forecast inflation of three percent by the end of the year.
Here, too, politicians have made a reservation. Macklem acknowledged that bank inflation forecasts depend heavily on global factors such as energy prices. And while commodity prices have improved recently, the stability of service sector inflation is another risk to the bank’s outlook, he said.
“Inflation is still above 6 percent. Yes, we certainly see clear evidence that inflation is falling. But we must be humble. There are some risks,” he said.
Macklem explained that just because the bank uses a target range of 1% to 3% to guide Canadian inflation expectations, the central bank will not accept 3% inflation — it will continue to tighten monetary policy until the mandatory target is reached. two percent.
The lull in rate hikes could end if banks see “increasing evidence” that inflation and other economic indicators are not performing as policymakers have hoped, said Macklem.
Asked by reporters whether interest rates could fall, the central bank governor dismissed speculation in money markets that a rate cut was imminent before the end of 2023.
A recession is still expected, said the Bank of Canada
An Ipsos Public Affairs poll conducted last week exclusively for Global News found that 68 percent of Canadians believe interest rates will rise faster than they can sustain.
Speaking to reporters on Wednesday, Conservative Party leader Pierre Poillievre called the rate hike a “disgusting blow” to Canadians but falsely claimed the decision was made by the Liberal government. The Bank of Canada is an independent institution that manages the country’s monetary policy.
Prime Minister Justin Trudeau was also asked on Wednesday about the latest rate hike and whether it will affect his policy agenda as Canadians grapple with rising costs.
He reiterated the government’s position that it would avoid support, which fuels inflation, and disagreed with the Bank of Canada’s efforts to curb demand spending.
“By targeting our support and making the kinds of investments that will ensure continued economic growth for years to come, we can support Canadians without jeopardizing the path the Bank of Canada has laid out for us to reduce inflation,” he said.
Macklem acknowledged on Wednesday that rising cumulative interest rates would weigh on the Canadian economy and strain the budget, though he claimed the spending was necessary to slow demand and ultimately cool inflation.
“It’s not painless. We’re raising interest rates a lot, which is affecting a lot of Canadians. We can see it’s working… we think it’s going to continue to permeate the economy,” he said.
Amid revised economic forecasts, the Bank of Canada still expects two-quarters of near-zero growth by 2023. Macklem reiterated that the economy could go negative and end in a recession, but he said it probably won’t be as bad as past downturns.
“This could be a mild recession. The contractions weren’t big,” he said.
Many economists agreed with Macklem, calling for a mild or moderate recession amid a global slowdown.
A recession is often defined as two consecutive quarters of negative GDP growth.
Some called for a limited impact on Canada’s job market, which remains tight with an unemployment rate of 5.0 percent. Deloitte said in forecasts last week that layoffs could be dampened in the recession as companies withhold workers over fears of not being able to hire after the downturn.
However, Macklem warned on Wednesday that the job market remains too tight and needs to be “rebalanced” before the Bank of Canada’s tightening cycle ends. If employment remains stable, inflationary pressures in the services sector are likely to remain high, he said.
While Macklem said annual wage increases are likely to be “flat” at around 5 percent and reduce potential wage inflation, he noted the labor market remains an area bank policymakers will be watching to see if interest rates should increase further in 2023.
“If the labor market is unstable if it stays very tight and it’s keeping prices down, we have to consider that.”