Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line
The Bank of Canada kept its policy rate to 5.00% and will continue quantitative tightening (QT), in line with our expectations.
The key message in today’s decision is that the BoC sees clear signs that higher interest rates are working at moderating spending and reducing price pressures. However, the progress toward bringing inflation to target is slower than they would want to see and inflationary risks have increased. As such, the BoC points to solid wage growth, inflation expectations, corporate pricing behaviours and elevated momentum in measures of core inflation as reasons that could lead to an increase in the policy rate, if necessary.
It remains clear that if there were a tug-of-war between economic activity and fighting inflation, the BoC would choose the fight against inflation. With this in mind, we believe that the BoC is likely on the sideline for the rest of the year as long as inflation continues to decelerate gradually. However, further rate increases cannot be fully ruled out if inflation were to prove more persistent than expected, even though the probability of such an outcome is low in our view.
The BoC leaves its policy rate at 5.00%, as expected. It also continued its quantitative tightening policy. In its statement, the BoC says that “clearer signs that monetary policy is moderating spending and relieving price pressures” was the main justification to keep rates unchanged although “inflationary risks have increased.” The central bank left the door open to further rate hikes and the Bank mentioned that it will continue “to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour.” The BoC also makes it clear that it “remains resolute in its commitment to restoring price stability for Canadians,” suggesting that it stands ready to act decisively if inflationary pressures do not ease and remain stubbornly sticky.
The BoC sees the global economy as slowing and further easing in growth is expected as past increases in policy rates and higher bond yields weigh on demand. The Bank notes that global inflation “has been easing in most economies, as supply bottlenecks resolve and weaker demand relieves price pressures. However, with underlying inflation persisting, central banks continue to be vigilant.” The central upgrade its outlook for the US economy, while China and the Eurozone are expected to be weaker.
In the Canadian economy, “there is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures”. The Bank notes that consumption has been subdued, while higher borrowing costs have weighed on business investment. On the flip side, a surging population is providing support to housing demand and spending but also easing some of the labour market pressures. Job gains have been weaker than labour force growth and job vacancies have continued to ease. Nevertheless, “the labour market remains on the tight side and wage pressures persist.” Overall, the BoC believes that “a range of indicators suggest that supply and demand in the economy are now approaching balance.”
The Bank expects growth to remain weak for the next year due to continued impact from higher interest rates and weaker global growth before improving in late 2024 and in 2025, thanks to improved household spending and foreign demand. Growth is expected to be weaker in 2023 and 2024, at 1.2% and 0.9%, respectively, while 2025 was revised marginally higher to 2025.
The BoC notes that inflation has been volatile in recent months but continues to expect further moderation. The Bank highlights progress in food price inflation and the continued impact of higher interest in “moderating inflation in many goods that people buy on credit” and some spillovers to services. However, it notes that housing costs and rent inflation remain high. Moreover, the central bank highlights that “near-term inflation expectations and corporate pricing behaviour are normalizing only gradually, and wages are still growing around 4% to 5%,” as a potential risk to the inflation outlook. The inflation outlook was revised higher in the near term to take into account higher energy prices and continued persistence in inflation. Nevertheless, the timing for inflation to return to the target remains in 2025.
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Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.