Affordability in Canada sustained another blow this morning as the Bank of Canada (BOC) raised its key benchmark interest rate to 5 percent.
This quarter-point increase was widely anticipated by analysts, given that inflation was still stubbornly high at 3.4 percent in May, still well above the target of 2 percent.
This latest rate increase represents levels not seen since April 2001, meaning an entire generation of homeowners have not experienced these kinds of borrowing costs.
In addition to raising the benchmark rate, the BOC announced that they anticipate the timeline for their tightening campaign is likely to be extended, with economic momentum continuing despite a substantial series of rate hikes.
They now forecast that inflation will stay close to 3 percent throughout the next year, not reaching the target of 2 percent until mid-2025.
Most analysts felt that because of these rate hikes, the economy would have tipped into recessionary territory by now, but the Canadian economy has remained unexpectedly resilient in the face of increased borrowing costs and high inflation.
Underlying prices remain sticky, slowing the decline of inflation levels. Several factors continue to contribute, including a growing population, a tight labour market, ongoing government spending through rebates and refunds and accumulated household savings all driving spending into the economy.
The BOC continues to try to find the balance between pulling back runaway inflation and placing burden on households, amid ongoing affordability challenges.
Bank of Canada raises policy rate 25 basis points, continues quantitative tightening
FOR IMMEDIATE RELEASE
July 12, 2023
The Bank of Canada today increased its target for the overnight rate to 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. The Bank is also continuing its policy of quantitative tightening.
Global inflation is easing, with lower energy prices and a decline in goods price inflation. However, robust demand and tight labour markets are causing persistent inflationary pressures in services. Economic growth has been stronger than expected, especially in the United States, where consumer and business spending has been surprisingly resilient. After a surge in early 2023, China’s economic growth is softening, with slowing exports and ongoing weakness in its property sector. Growth in the euro area is effectively stalled: while the service sector continues to grow, manufacturing is contracting. Global financial conditions have tightened, with bond yields up in North America and Europe as major central banks signal further interest rate increases may be needed to combat inflation.
The Bank’s July Monetary Policy Report (MPR) projects the global economy will grow by around 2.8% this year and 2.4% in 2024, followed by 2.7% growth in 2025.
Canada’s economy has been stronger than expected, with more momentum in demand. Consumption growth has been surprisingly strong at 5.8% in the first quarter. While the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent retail trade and other data suggest more persistent excess demand in the economy. In addition, the housing market has seen some pickup. New construction and real estate listings are lagging demand, which is adding pressure to prices. In the labour market, there are signs of more availability of workers, but conditions remain tight, and wage growth has been around 4-5%. Strong population growth from immigration is adding both demand and supply to the economy: newcomers are helping to ease the shortage of workers while also boosting consumer spending and adding to demand for housing.
As higher interest rates continue to work their way through the economy, the Bank expects economic growth to slow, averaging around 1% through the second half of this year and the first half of next year. This implies real GDP growth of 1.8% in 2023 and 1.2% in 2024. The economy will move into modest excess supply early next year before growth picks up to 2.4% in 2025.
Inflation in Canada eased to 3.4% in May, a substantial and welcome drop from its peak of 8.1% last summer. While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation. With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation. Moreover, with three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank’s business surveys, which find businesses are still increasing their prices more frequently than normal.
In the July MPR projection, CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.
In light of the accumulation of evidence that excess demand and elevated core inflation are both proving more persistent, and taking into account its revised outlook for economic activity and inflation, Governing Council decided to increase the policy interest rate to 5%. Quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the Bank’s balance sheet. Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.
