Bank of Canada Responds to Economic Pressures with 5% Rate Hike
On Wednesday, the Bank of Canada announced a pivotal increase in the overnight rate to 5%, along with corresponding increases in the Bank Rate and deposit rate. This move coincides with the Bank's continuation of its quantitative tightening policy.
Global inflation trends are shifting downwards, largely due to reductions in energy prices and goods price inflation. Despite these trends, the service sector is experiencing persistent inflationary pressures owing to robust demand and tight labour markets. Amid unexpectedly strong economic growth, particularly in the United States, bond yields in North America and Europe have increased, signaling potential further interest rate hikes to control inflation.
The Bank's July Monetary Policy Report (MPR) projects a growth of 2.8% in the global economy for 2023, 2.4% in 2024, and a rebound to 2.7% in 2025.
The report indicates that “the next stage in the decline of inflation towards target is expected to take longer and is more uncertain. This is partly due to elevated services inflation, which can adjust sluggishly, and uncertainty about expected inflation.”
While initial expectations were for consumer spending to slow due to increased interest rates, the data suggests a continued excess demand, stimulated in part by a buoyant housing market and a tight labour market, despite greater workforce availability.
The Bank forecasts that economic growth will moderate, averaging around 1% through the second half of 2023 and the first half of 2024. This implies real GDP growth rates of 1.8% in 2023 and 1.2% in 2024, with a modest period of excess supply early next year before growth rebounds to 2.4% in 2025.
Canadian inflation dropped to 3.4% in May, a notable decrease from the previous summer's peak of 8.1%. However, the lower inflation rate is largely driven by reduced energy prices rather than a genuine easing of underlying inflation. The MPR forecasts that CPI inflation will remain around 3% for the next year before gradually declining to the Bank's target of 2% by mid-2025.
Given the revised outlook for economic activity and inflation, the Bank decided to raise the policy interest rate to 5%.
The Bank is scheduled to announce the next overnight rate target on September 6, 2023. The Bank remains steadfast in its commitment to restoring price stability for Canadians.
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