Bank of Canada Keeps Policy Rate Steady

The Bank of Canada today announced that it would maintain its policy interest rate at 5%.

Despite a decrease in inflation since the summer of 2022, the Bank emphasised that inflation levels in Canada remain high. The decision to keep the policy rate unchanged reflects the central bank's belief that monetary policy (i.e., the high current policy interest rate) is effectively cooling the economy and alleviating inflationary price pressures. However, policymakers expressed concerns that further reductions in inflation could be slow, and they noted an increase in inflationary risks, which might require a rate increase in the future.

Global Economic Backdrop

Addressing the global economic landscape, the Bank of Canada recognised that expected global economic growth is slowing due to higher global interest rates and tighter financial conditions affecting demand. However, there have been deviations from the economic forecasts made in July. The U.S. economy has displayed unexpected strength, while China's economy has slowed more than initially predicted. Moreover, rising geopolitical tensions, particularly the ongoing Russian aggression against Ukraine and the conflict in Israel and Gaza have contributed to global economic uncertainty.

Canadian Economy

In the Canadian context, the central bank reported that the economy has decelerated, and data suggests that demand and supply are approaching equilibrium. As the economy is projected to move into excess supply, with weak growth anticipated in the coming quarters, the bank expects price pressures to abate further. The goal is for inflation to gradually ease, ultimately returning to the 2% target by 2025. However, concerns were raised about the persistence of high energy prices and underlying inflation.

Over the past year, higher interest rates have led to evidence of moderating spending and a rebalancing of demand and supply. The economic growth rate has averaged around 1%, household credit growth has slowed, and there has been a decline in demand for housing and durable goods. Recent data also shows a deceleration in the services sector. The Bank of Canada has therefore revised down its growth outlook, with GDP growth expected to remain below 1% for the next several quarters before a projected pickup in late 2024, eventually reaching 2.5% in 2025.

While job vacancies have decreased, they remain above typical levels, and wage growth remains elevated at 4% to 5%. These demand pressures have eased more rapidly than initially forecast in July.

The bank acknowledged that tighter monetary policy is already reducing price pressures in various goods and services categories, particularly in durable and semi-durable goods. However, inflation expectations remain elevated, and the bank has revised its inflation outlook upwards. Factors contributing to this upward revision include persistently high energy prices, structural housing market issues, and ongoing elevated inflation expectations. As a result, the Bank of Canada now anticipates that inflation will reach approximately 3.5% through the middle of 2024.

Risks

The central bank recognised both upside and downside risks to this inflation forecast. The future path for inflation remains uncertain, with inflationary risks elevated compared to July. Rising global tensions also pose additional risks, potentially leading to higher energy prices and supply chain disruptions on a global scale.

Rates Might Rise Further

Despite these uncertainties, the Bank of Canada expressed confidence in the effectiveness of its monetary policy. The Governing Council collectively judged that it could exercise patience and maintain the policy rate at 5%. However, they affirmed their commitment to closely monitoring risks and assessing whether the current policy rate is sufficiently restrictive to restore price stability. If inflationary pressures persist, the bank remains prepared to raise the policy rate further.

The Current Tightening Cycle will Continue into 2024

In closing, the Bank of Canada emphasised that although progress has been made, they are not yet satisfied with the current state of the economy. Their commitment to maintaining price stability remains steadfast as they navigate the uncertain economic terrain.