The Bank of Canada duly delivered a further rate increase this morning, but in the form of a 50 basis point move rather than the 75 bp that markets were expecting. The overnight rate target now stands at 3.75 percent. The smaller move may be taken as a hint that the Bank thinks it is nearing the end of its tightening cycle, but it is clear from the press release and the updated Monetary Policy Report that it still expects to tighten further.
The text of the press release is somewhat longer than usual and is largely the same as the Overview section of the MPR. Here are a few highlights:
On global inflation: Inflation around the world remains high and broadly based. This reflects the strength of the global recovery from the pandemic, a series of global supply disruptions, and elevated commodity prices, particularly for energy, which have been pushed up by Russia’s attack on Ukraine...... As economies slow and supply disruptions ease, global inflation is expected to come down.
On global growth: The Bank projects no growth in the US economy through most of next year. In the euro area, the economy is forecast to contract in the quarters ahead, largely due to acute energy shortages...... Overall, the Bank projects that global growth will slow from 3% in 2022 to about 1½% in 2023......This is a slower pace of growth than was projected in the Bank’s July Monetary Policy Report (MPR).
On Canadian growth: In Canada, the economy continues to operate in excess demand and labour markets remain tight. The demand for goods and services is still running ahead of the economy’s ability to supply them, putting upward pressure on domestic inflation.......The effects of recent policy rate increases by the Bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softening. Also, the slowdown in international demand is beginning to weigh on exports....... The Bank projects GDP growth will slow from 3¼% this year to just under 1% next year and 2% in 2024.
On Canadian inflation: In the last three months, CPI inflation has declined from 8.1% to 6.9%, primarily due to a fall in gasoline prices. However, price pressures remain broadly based, with two-thirds of CPI components increasing more than 5% over the past year..... Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched......The Bank expects CPI inflation to ease as higher interest rates help rebalance demand and supply, price pressures from global supply disruptions fade.....CPI inflation is projected to move down to about 3% by the end of 2023, and then return to the 2% target by the end of 2024.
The TL:DR version of this seems to be that the Bank believes its policy actions (and those of the Fed and others) are starting to have the desired effects, but it is still too soon to contemplate the much-discussed "pivot". All the same, it is surely significant that the Bank has opted for a smaller move this time, and it will be interesting to see whether other Central Banks are similarly inclined. Certainly, if the Fed shares the Bank of Canada's view that the US economy will show no growth in 2023, some similar policy signal will soon become appropriate there.
One additional factor not mentioned by the Bank is the status of Canadian fiscal policy. For the first four months of the current fiscal year (which runs April-March), the Federal budget has been in surplus, and several Provinces are reporting similar results. It is unlikely that this will persist at the Federal level for the full fiscal year, but fiscal policy is providing very much less stimulus to the economy now than it did during the pandemic. This heightens the risk that monetary policy might overshoot what is needed to get inflation back to the target level.
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