It's coming (and so is Christmas)

Ahead of today's Bank of Canada Governing Council meeting, markets had begun to contemplate the possibility that the Bank's first rate hike might come as early as the first quarter of 2022.  The Bank has firmly put paid to any such expectations, with today's press release striking a surprisingly dovish tone and reaffirming the Bank's expectation that the tightening cycle will not begin until "the middle quarters" of next year.  

Market expectations for an earlier rate hike seemed well-founded, based on the latest economic data. The economy grew at a 5.5 percent annualized rate in Q2; employment grew by a remarkable 154,000 jobs in November, regaining all the losses caused by the pandemic; and inflation has been steadily rising throughout the year, reaching a multi-decade high of 4.7 percent in October. 

Despite these developments, the Bank believes that the economy "continues to require considerable monetary policy support". While admitting that the economy showed considerable momentum at the start of Q4, it argues that the omicron COVID variant and the devastating floods in British Columbia could weigh on growth, mainly by exacerbating supply chain disruptions. Concerns about omicron seem to wax and wane almost on a daily basis, while the impact of the BC floods is ambiguous at best. Arguably, the massive reconstruction efforts already under way could actually boost GDP growth in Q1 and beyond. 

As for inflation, the Bank remains convinced that the recent spike will prove transitory. It notes that gasoline prices, a major driver of recent increases in CPI, have recently eased, partly in response to the emergence of the omicron variant. It says core measures of inflation "are little changed since September", which seems a very small sample size to be relying on. It expects CPI to remain elevated through the first half of 2022 and to "ease back towards" 2 percent in the second half of the year. That form of words seems carefully chosen to cover the possibility that even if it begins to ease, CPI may remain above target all  through next year. This is surely not what the Bank had in mind when it first used the term "transitory". 

The Bank is taking a risk here. Taken at face value, the recent data on both growth and inflation seem to cry out for an early policy response.  The 2 percent inflation target has been the pillar of the Bank's policy approach for nigh on three decades. It is tempting to speculate that the approach it is now taking points to a broadening of its policy mandate, which is is set to be renewed almost any day now. 

UPDATE, December 9: This new report predicts that Canadians' food bills will rise 5-7 percent in 2022. Meanwhile it looks as if gasoline prices are on the rise again, after a brief fall triggered by the arrival of the omicron variant. Given the importance of these two items in most households' budgets, these trends will make it very difficult for the Bank of Canada to keep inflation expectations in check.