No rate hike — for now
Bank prepared for more increases if needed this year
For the first time in more than a year, the Bank of Canada is leaving interest rates alone, but is warning that more increases are possible as it attempts to wrestle inflation under control.
The bank announced Wednesday morning that it was keeping its key overnight rate at 4.5 per cent.
“Governing council will continue to assess economic developments and the impact of past interest rate increases, and is prepared to increase the policy rate further if needed to return inflation to the two per cent target,” the bank said in its announcement.
A survey of economists by Reuters last week predicted the bank would leave its key overnight rate at 4.5 per cent for 2023, though trading in the overnight “swaps” market is pricing in a quarter-percentage point hike by the end of the year.
Last March, the bank began an aggressive rate-hike campaign as it attempts to bring inflation down, pushing the overnight rate to 4.5 per cent from 0.25 per cent. In January, a hike of 25 basis points (a quarter of a percentage point) came with a statement from governor Tiff Macklem that it was pausing hikes — at least for the moment. Prime rates — charged by banks to their best customers — typically move when the overnight rate does. And mortgage rates, particularly variable ones, soon follow.
In Wednesday’s statement, the bank said previous interest rate hikes are still working their way through the economy, but also suggested a “very tight” labour market, “surprisingly high” employment growth and persistent wage growth are keeping inflation high.
That makes it clear the bank is considering another increase this year, said BMO chief economist Douglas Porter. “The language seems to have changed slightly around the pause … They’re not in neutral. They’re definitely leaning toward hiking interest rates if they have to.”
In January, the annual rate of inflation fell to 5.9 per cent, according to Statistics Canada. While that’s substantially lower than the 8.1 per cent it peaked at last June, it’s still well above the bank’s target of two per cent. The theory is that by making it more costly to borrow money by increasing interest rates, people and businesses will spend less, eventually driving prices down.
The sluggish economic growth seen in the fourth quarter and falling inflation are arguments against a rate hike, while two straight months of higher-than-expected job numbers are pushing in the opposite direction. That means the bank was right to leave the overnight rate alone, said Pedro Antunes, chief economist at the Conference Board of Canada.
“It’s a bit of a mixed bag,” said Antunes. “I think ‘wait and see’ is probably the right approach for them to take right now.”
The odds of a rate hike in Canada increased after a speech Tuesday by U.S. Federal Reserve chair Jerome Powell in which he suggested the Fed may need to increase its own benchmark rate higher than the 5.5 per cent it forecast, Antunes said.
If there’s too much of a spread between the Bank of Canada’s overnight rate and the Fed’s benchmark rate, bond market investors will likely put more of their money into the U.S., to get a higher return. That, in turn, will drive the value of the Canadian dollar down against the U.S. currency. If that happens, inflation in this country will get another upwards push, Antunes said.
“If our currency drops, the price of imports — which is pretty much everything we consume — goes up,” he said.
National Bank Financial economists Taylor Schleich and Warren Lovely said that if the spread between Canada’s overnight rate and the Fed funds rate grows to 1.5 percentage points or higher, the Bank of Canada could be tempted to try to narrow the gap.
Another rise in the overnight rate would be a mistake that could inflict substantial damage on the Canadian economy, said Jim Stanford, an economist with the Centre for Future Work.
“I’m glad that they paused, but I’m deeply concerned we could end up having a situation where the economy is shrinking but they raise rates anyway because they’re obsessed with the two per cent target no matter what,” said Stanford, who also said the bank has a philosophical blind spot that ignores rising corporate profits as a source of inflation.
Bank of Canada senior deputy governor Carolyn Rogers is expected to shed more light on the bank’s thinking Thursday when she gives an “economic progress report” to the Manitoba Chamber of Commerce.
The language seems to have changed slightly around the pause … They’re not in neutral. They’re definitely leaning toward hiking interest rates if they have to.
DOUGLAS PORTER BMO CHIEF ECONOMIST