A pause for the cause

In line with market expectations, the Bank of Canada today raised its overnight rate target by 25 basis points, bringing it to 4.5 percent. More significantly, in his subsequent press briefing Governor Tiff Macklem explicitly announced a pause in tightening: "With today’s modest increase, we expect to pause rate hikes while we assess the impacts of the substantial monetary policy tightening already undertaken". 

The media release is much more detailed than usual in its analysis of the economic situation, and further details can be found in the updated Monetary Policy Report. The Bank notes that the economy has grown slightly faster than expected in recent months, but it sees signs that past monetary policy moves are now working to slow activity, especially household spending: "Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially. As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment are expected to slow".  This is likely true, but whether slowing demand is the main reason inflation is declining rapidly is it is of course a quite different question, and one that may cast doubt on whether the Bank's policy actions have had much impact at all on inflation.

The Bank's latest forecast sees GDP growth stalling in the first half of this year but picking up later, to give real GDP growth for the full year of just 1 percent, down from an estimated 3.6 percent in 2022. It expects headline CPI, most recently standing at 6.3 percent year-on-year, to fall to 3 percent by mid-year and to return to the 2 percent target by 2024. Barring new geopolitical shocks, it is possible to construct scenarios in which the 2 percent target is reached some time this year, but whether the actual outcome is 2 percent or 3 percent, the decline will owe much more to "base effects", as last year's bloated monthly numbers fall out of the index, than to anything the Bank has done. 

Macklem tempered his promise of a pause with a warning:  "To be clear, this is a conditional pause—it is conditional on economic developments evolving broadly in line with our MPR outlook. If we need to do more to get inflation to the 2% target, we will". Fair enough, but it seems more than likely that the Bank has reached the end of this tightening cycle, and having official rates back in more historically normal territory can only be a welcome development. There are already a few commentators predicting that rates will start falling again in the second half of this year. You wouldn't rule it out.