The Bank of Canada has announced its decision to raise the target for the overnight rate to 4¾%, while adjusting the Bank Rate to 5% and the deposit rate to 4¾%. This move is in line with the central bank's ongoing strategy of quantitative tightening, underscoring its commitment to maintaining a prudent monetary policy stance. Despite a decline in global consumer price inflation due to lower energy prices, underlying inflation remains persistently high. Consequently, major central banks around the world are signalling the potential need for further interest rate hikes to restore price stability.
The United States is experiencing an economic slowdown, although consumer spending remains unexpectedly resilient and the labour market remains tight. In Europe, economic growth has stagnated, yet core prices continue to face upward pressure. China, after a surge in the first quarter, is expected to witness a deceleration in growth. Financial conditions have tightened, with levels reverting to those observed prior to the bank failures in the United States and Switzerland.
However, Canada's economy has outperformed expectations in the first quarter of 2023, with a robust GDP growth rate of 3.1%. Consumption growth has been strong and broad-based, even after accounting for population gains. The demand for services has rebounded while spending on interest-sensitive goods has increased. The housing market has also seen a recent uptick in activity. Although the labour market remains tight, with higher immigration and participation rates expanding the workforce, new workers have been swiftly hired due to sustained strong labour demand. This has resulted in a more persistent excess demand in the Canadian economy than anticipated.
In terms of inflation, the consumer price index (CPI) rose to 4.4% in April, marking the first increase in 10 months. Prices for a broad range of goods and services exceeded expectations. Goods price inflation increased, despite lower energy costs, while services price inflation remained elevated due to strong demand and a tight labour market. The Bank of Canada expects CPI inflation to ease to around 3% during the summer as lower energy prices filter through and the significant price gains from the previous year drop out of the annual data. However, concerns have arisen that CPI inflation could remain significantly above the 2% target, given sustained three-month measures of core inflation in the 3½-4% range and the persistence of excess demand.
Based on an assessment of the available evidence, the Governing Council of the Bank of Canada has decided to raise the policy interest rate. This decision reflects their view that current monetary policy measures are not sufficiently restrictive to rebalance supply and demand and achieve sustainable inflation at the 2% target. In conjunction with the rate hike, the Bank will continue with its quantitative tightening measures, which work in tandem with the restrictive monetary policy stance to normalize the Bank's balance sheet.
Looking ahead, the Governing Council will closely monitor the dynamics of core inflation and the outlook for CPI inflation. Factors such as the evolution of excess demand, inflation expectations, wage growth, and corporate pricing behaviour will be carefully evaluated to assess their alignment with the inflation target. The Bank remains resolute in its commitment to restoring price stability for the benefit of Canadians.
The next scheduled announcement for the overnight rate target is July 12, 2023, at which time the Bank of Canada will provide a comprehensive outlook on the economy and inflation, including an assessment of risks to the projection, in the Monetary Policy Report.
Source: Bank of Canada