One small step

As expected, the Bank of Canada today raised its overnight rate target by 25 basis points to 0.5%, the first rate increase since 2018. It signaled that more rate hikes are coming, despite growing uncertainty over the outlook, but for the time being is holding off on reducing the size of its balance sheet. 

The case for rate hikes was clear by the start of this year and recent economic data have only served to underline it. Economic growth in Q4/2021 was well above the Bank's expectations at 6.7 percent (annualized rate), which "confirms its view that economic slack has been absorbed".  The Bank believes that the impact of the omicron COVID variant is already fading, so that "first-quarter growth is now looking more solid than previously projected".

As for inflation, the January reading of 5.1 percent is of course far above the Bank's target range: "Price increases have become more pervasive, and measures of core inflation have all risen". Monetary policy may have little effect on the current causes of inflation, but the Bank's concern is to ensure that inflation expectations do not drift away from the 2 percent target. Therefore "The Bank will use its monetary policy tools to return inflation to the 2 % target and keep inflation expectations well-anchored". 

Viewed in a vacuum, this language and the recent data would clearly signal the Bank's intention to raise rates several more times during 2022 , and until a week ago this was the consensus expectations among Bank-watchers. The Russian invasion of Ukraine is a huge complicating factor. Gasoline prices at the retail level are set to reach all-time highs by this weekend in response to the soaring cost of crude, and the impact of the war will inevitably spill over into other commodities, as the Bank's press release makes clear.

The growth impact of the events in Ukraine is more complicated from a policy standpoint. The press release notes that "negative impacts on confidence and new supply disruptions could weigh on global growth". In the aggregate this is certainly true, but as Canada is a net energy exporter, the impact is likely to vary widely across the country. The oil patch in Alberta and Saskatchewan was already booming before the Ukraine crisis boosted energy prices yet further, while energy importing Provinces such as Ontario could take a significant hit. This will create a tricky balancing act for the Bank:  2022 shapes up as one of those years where a "one size fits all" monetary policy is way less than ideal.