Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa on April 12, after the central bank announced it would hold its key rate steady.BLAIR GABLE/Reuters
The Bank of Canada held interest rates steady on Wednesday while pushing back against market expectations that it will start cutting rates later this year.
The widely anticipated move kept the benchmark lending rate at 4.5 per cent, reinforcing the bank’s decision last month to pause its rate-hike campaign after eight consecutive increases.
Central bank economists expect inflation to fall rapidly in the coming months. However, Governor Tiff Macklem warned Wednesday that it may take longer than previously expected to get inflation back to the bank’s 2-per-cent target, and he suggested that interest rates may need to remain elevated for some time.
“Inflation is coming down quickly and is forecast to be around 3 per cent this summer,” Mr. Macklem said in a news conference after the rate announcement.
“This is good news, but it is not job done,” he said. “If monetary policy is not restrictive enough to get us all the way back to the 2-per-cent target, we are prepared to raise the policy rate further to get there.”
The annual rate of consumer price index inflation was 5.2 per cent in February, down from a four-decade high of 8.1 per cent reached last June. The bank expects inflation to fall to 2 per cent by the end of 2024.
For now, Mr. Macklem and his team are in a holding pattern, waiting to see whether the huge increase in borrowing costs they orchestrated between March, 2022, and January, 2023, will be enough to bring inflation down over time.
Interest-rate hikes work with a lag, curtailing spending as homeowners renew their mortgages at higher rates and businesses pull back on investment. The bank is intentionally trying to cool the economy and lower demand for goods and services to slow the speed of price increases.
The results of the rate-hike campaign are still pending. Canada’s economy was surprisingly robust in early 2023. Gross domestic product grew more than expected in January and unemployment remained near a record low through March. That led the bank to upgrade its 2023 GDP growth forecast to 1.4 per cent, from 1 per cent forecast in January. It downgraded its 2024 GDP growth forecast to 1.3 per cent from 1.8 per cent.
This relative economic strength is not expected to last. The bank’s latest forecast sees a decline in consumer spending in the coming quarters, alongside a drop in international trade and business investment as the U.S. economy stumbles. This could be compounded by a pullback in commercial bank lending following recent turmoil in the U.S. and European banking sectors, the bank said.
Mr. Macklem argues that a period of economic weakness is needed to lower inflationary pressures. But he is not expecting a major contraction this year: “We’re not forecasting large increases in unemployment, and in that sense, it’s not what people associate with the word ‘recession,’” he said.
Most investors and analysts believe the central bank is done hiking interest rates, and many of them have turned to speculating about when it will start cutting rates. Interest-rate swap markets, which capture market expectations about future monetary policy decisions, foresee a quarter-point rate cut in December.
It’s a long way back to 2-per-cent inflation
Mr. Macklem pushed back against those expectations in the news conference, saying that the prospect of rate cuts later this year “doesn’t look today like the most likely scenario to us.”
“Banking turmoil has erased market odds of the BoC restarting its tightening cycle,” Josh Nye, senior economist with Royal Bank of Canada, wrote in a note to clients. “But today’s statement seems to be a reminder that the bank has a tightening, not an easing bias, and investors might be underestimating the potential for further rate hikes.”
Inflation has been trending down since last summer, largely thanks to a fall in energy prices and a slowdown in durable goods inflation. Global supply chains have improved and transportation costs have fallen significantly. CPI inflation came in below central bank and Bay Street estimates in January and February.
That said, service sector inflation remains high, driven in part by tight labour markets and fast-rising wages. To get inflation back to 2 per cent, wage growth needs to moderate, public expectations for inflation need to decline, and companies need to return to more normal price-setting behaviour after a period during which many businesses have been quick to pass cost increases along to customers, Mr. Macklem said.
“The Bank’s messaging still has a hawkish tilt, despite its decision to leave interest rates on hold,” Canadian Imperial Bank of Commerce chief economist Avery Shenfeld wrote in a note to clients.
“The emphasis in the statement is on the cup being only half full when it comes to having the ingredients needed to meet its inflation targets,” he wrote.
The bank did offer a number of positive nuggets in its updated quarterly Monetary Policy Report. It highlighted recent population growth, which has boosted the labour supply. “This means that the economy may be able to grow at a somewhat faster pace than previously expected without generating additional inflationary pressures,” the bank said.
It also said that food price inflation should slow in the months ahead following “recent easing of cost pressures in production and distribution.” Food prices have continued to grow rapidly in recent months, even as broader inflation has declined.
In an unusual step, the report also spells out the impact of recent federal and provincial government measures which include direct transfers to individuals aimed at reducing the impact of inflation. Critics say these programs are boosting consumer spending at the same time the central bank is trying to cool it. The bank said additional fiscal measures totalled around $25-billion each year, compared with the bank’s last quarterly report in January.
Mr. Macklem gave a diplomatic answer when asked about the fiscal measures during the news conference. “The way I would put it is that government spending plans are not contributing to the slowing of growth that you see in our projection, but at the same time, they’re not standing in the way of getting inflation back to the 2-per-cent target,” he said.
The bank mostly downplayed the impact of the financial sector stress that has emerged following the failure of Silicon Valley Bank and the emergency sale of Credit Suisse, saying that credit conditions had “tightened modestly.” But a broader financial crisis is a significant downside risk, the bank said in its report.
“If global banking stresses intensify further, global credit conditions could tighten significantly. If this risk materializes, a more severe global slowdown and sharply lower commodity prices could follow,” the bank said.