Archives July 2022

The Bank of Canada today increased its target for the overnight rate to 2½%, with the Bank Rate at 2¾% and the deposit rate at 2½%. The Bank is also continuing its policy of quantitative tightening (QT).

Inflation in Canada is higher and more persistent than the Bank expected in its April Monetary Policy Report (MPR), and will likely remain around 8% in the next few months. While global factors such as the war in Ukraine and ongoing supply disruptions have been the biggest drivers, domestic price pressures from excess demand are becoming more prominent. More than half of the components that make up the CPI are now rising by more than 5%. With this broadening of price pressures, the Bank’s core measures of inflation have moved up to between 3.9% and 5.4%. Also, surveys indicate more consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price- and wage-setting. If that occurs, the economic cost of restoring price stability will be higher.

Global inflation is higher, reflecting the impact of the Russian invasion of Ukraine, ongoing supply constraints, and strong demand. Many central banks are tightening monetary policy to combat inflation, and the resulting tighter financial conditions are moderating economic growth. In the United States, high inflation and rising interest rates are contributing to a slowdown in domestic demand. China’s economy is being held back by waves of restrictive measures to contain COVID-19 outbreaks. Oil prices remain high and volatile. The Bank now expects global economic growth to slow to about 3½% this year and 2% in 2023 before strengthening to 3% in 2024.

Further excess demand has built up in the Canadian economy. Labour markets are tight with a record low unemployment rate, widespread labour shortages, and increasing wage pressures. With strong demand, businesses are passing on higher input and labour costs by raising prices. Consumption is robust, led by a rebound in spending on hard-to-distance services. Business investment is solid and exports are being boosted by elevated commodity prices. The Bank estimates that GDP grew by about 4% in the second quarter. Growth is expected to slow to about 2% in the third quarter as consumption growth moderates and housing market activity pulls back following unsustainable strength during the pandemic.

The Bank expects Canada’s economy to grow by 3½% in 2022, 1¾% in 2023, and 2½% in 2024. Economic activity will slow as global growth moderates and tighter monetary policy works its way through the economy. This, combined with the resolution of supply disruptions, will bring demand and supply back into balance and alleviate inflationary pressures. Global energy prices are also projected to decline. The July outlook has inflation starting to come back down later this year, easing to about 3% by the end of next year and returning to the 2% target by the end of 2024.

With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today. The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank’s ongoing assessment of the economy and inflation. Quantitative tightening continues and is complementing increases in the policy interest rate. The Governing Council is resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target.

Information note

The next scheduled date for announcing the overnight rate target is September 7, 2022. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the MPR on October 26, 2022.

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The Bank of Canada increased its benchmark interest rate by one percentage point on Wednesday, the most aggressive rate hike since 1998 and a larger move than investors and private-sector economists were expecting.

The central bank’s governing council voted to raise its policy rate to 2.5 per cent from 1.5 per cent. This is the fourth consecutive interest rate increase since March, and puts the Bank of Canada ahead of its peers when it comes to tightening monetary policy in the face of the most significant inflation shock in a generation.

“With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the governing council decided to front-load the path to higher interest rates,” the bank said in its rate decision statement.

The bank signaled that interest rates will need to keep rising to cool down Canada’s overheated economy and slow the pace of consumer price growth.

Ahead of Wednesday’s announcement, investors and private-sector economists were widely expecting a 0.75 percentage point increase. The Bank of Canada’s governing council, however, opted for a super-sized move in response to broadening inflation pressures and worrying signs that inflation expectations are becoming unanchored.

The bank now expects the rate of inflation to average 7.2 per cent in 2022 and 4.6 per cent in 2023 – considerably higher than it forecast in April. It does not expect inflation to return to its 2 per cent target until the end of 2024.

Economic growth, meanwhile, is expected to slow sharply in the second half of the year and into next year, as a combination of high inflation and tighter financial conditions erodes household spending and business investment.

The bank is not forecasting a recession in Canada in the next two years as its base case. But its quarterly Monetary Policy Report, published Wednesday, does warn that the risk of a recession would rise if high inflation becomes baked into consumer and business psychology, triggering a wage-price spiral.

Wednesday’s supersized rate hike cements a remarkable pivot that has taken place in recent months at the Bank of Canada and other central banks around the world.

Governor Tiff Macklem and his team held interest rates near zero for the first two years of the COVID-19 pandemic, and were slow to start tightening monetary policy even as inflation began to pick up last year. This changed in March. Since then, the bank has been pushing interest rates higher at the fastest pace in decades.

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The annual rate of inflation hit 7.7 per cent in May, the highest since 1983. Inflation is becoming impossible to avoid, with more than half of the components of the consumer price index rising at an annual rate of more than 5 per cent in May. That’s aggravating cost-of-living concerns for many Canadians.

Higher rates make it more expensive for businesses and households to borrow money. This won’t do much to tamp down global inflationary pressures, such as supply chain bottlenecks and higher commodity prices, which have surged in the wake of Russia’s invasion of Ukraine. But it could help cool demand in the Canadian economy.

“While global factors such as the war in Ukraine and ongoing supply disruptions have been the biggest drivers, domestic price pressures from excess demand are becoming more prominent,” the bank noted in its rate decision.

The rapid rise in interest rates is also aimed at keeping inflation expectations anchored. One of the biggest concerns for central bankers is preventing people from losing faith in its inflation target.

The longer consumer prices keep surging, the more inflation will become entrenched in people’s psychology as happened in the 1970s. The fear is that a wage-price spiral could develop, where business and consumers expect higher prices, and so set higher prices and demand higher wages in a self-reinforcing cycle.

“Surveys indicated more consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price- and wage-setting. If that occurs, the economic cost of restoring price stability will be higher,” the bank said in its rate decision statement.

Higher interest rates are already impacting key segments of the economy, notably in the housing market. In the Toronto region, the largest real estate market in the country, the number of home resales dropped 41 per cent in June compared to last year. The typical Toronto home price is down nearly 10 per cent from the March peak to June.