The Bank of Canada raised its key interest rate by 25 basis points to 4.50%. A move that was widely expected by markets. This is the eight consecutive time the Bank of Canada has raised interest rates. And now, it seems they are done.
This could be the last rate hike in this hike cycle. The Bank of Canada in their statement said that they expect to hold the policy rate at its current level while they assess the impact of the cumulative 425 basis point increase.
We have raised rates rapidly, and now it’s time to pause and assess whether monetary policy is sufficiently restrictive to bring inflation back to the 2% target.
If economic developments stay in line with its current projections (an economic slowdown), then rates will remain here. BUT the Bank of Canada is still keeping the doors open for higher rates and action. It all depends on inflation.
“Governing council is prepared to increase the policy rate if needed to return inflation to the two per cent target,” the central bank said.
However, it seems for now that the risk for upside inflation in Canada will be thwarted by a severe global slowdown.
According to the central bank, recent data is showing that the high interest rates are dampening household spending, particularly on housing and big-ticket items. However, economic growth and employment were stronger than expected in the second half of 2022. The Bank of Canada also said that excess demand persists in the economy which keeps putting upward pressures on prices.
When it comes to inflation:
Consumer price index (CPI) inflation declined to 6.3% in December, reflecting lower global energy prices and some moderation in the prices for durable goods as supply improved and demand softened. Lower gasoline prices are welcome, but prices of essentials like groceries and rent continue to increase too quickly. Measures of core inflation have also been stuck at about 5%. With 3-month rates below year-over-year increases, core inflation will likely start to come down in the months ahead. Still, core inflation needs to continue to decline for total CPI inflation to get back to the 2% target.
The central bank also acknowledged the lag effect on restrictive monetary policy:
We know it takes time for higher interest rates to work through the economy to slow demand and reduce inflation. And given the speed and magnitude of the interest rate increases over the last year, their full effect is still to come.
And then the pause:
With today’s modest increase, we expect to pause rate hikes while we assess the impacts of the substantial monetary policy tightening already undertaken. To be clear, this is a conditional pause—it is conditional on economic developments evolving broadly in line with our MPR outlook. If we need to do more to get inflation to the 2% target, we will.
We are trying to balance the risks of under- and over-tightening. If we do too little, the decline in inflation will stall before we get back to target. But if we do too much, we will make the adjustment unnecessarily painful and undershoot the inflation target.
We’re still a long way from our target, but recent developments have reinforced our confidence that inflation is coming down. And we are committed to getting inflation all the way back to 2%, so that Canadians can once again count on low, stable and predictable inflation and sustainable economic growth.
The Bank of Canada is also forecasting the global economy slowing down to 2% in 2023 and 2.5% in 2024. In Canada, the central bank expects GDP to slow from 3.5% in 2022 to about 1% in 2023 and 2% in 2024.
The Canadian Loonie is overall down post the Bank of Canada announcement.
Against the US Dollar, the Loonie has depreciated today with an exchange rate at 1.3411.
The TSX exchange is at an important resistance zone, and is currently retesting a breakout. According to the technicals, we should be seeing a higher move in the TSX.
Now, all eyes and ears will be on Jerome Powell and the Federal Reserve next week. With the Bank of Canada going dovish, will the Fed do the same? Equity and bond markets are pricing in a Fed pivot or pause. But will Powell surprise markets and continue to ‘stay the course’.