Bank of Canada: on hold, for now

The Bank of Canada today kept its overnight rate target unchanged at 4.5 percent, in line with the "conditional" pause in tightening that it signalled at the previous Governing Council meeting. The press release makes it clear that the Bank is prepared to start raising rates again if it deems it necessary, but also gives some fairly specific guidance as to what it will take for rates to stay on hold. 

The Bank notes that economic developments over the past month have been broadly in line with expectations, but there are some important divergences that may have an impact on its policy options going forward. Internationally, In the United States and Europe, near-term outlooks for growth and inflation are both somewhat higher than expected in January. In particular, labour markets remain tight, and elevated core inflation is persisting. Growth in China is rebounding in the first quarter.   

In Canada, on the other hand, economic growth came in flat in the fourth quarter of 2022, lower than the Bank projected. With consumption, government spending and net exports all increasing, the weaker-than-expected GDP was largely because of a sizeable slowdown in inventory investment. Restrictive monetary policy continues to weigh on household spending, and business investment has weakened alongside slowing domestic and foreign demand.

The Bank believes that the relatively slow GDP growth it expects through the first half of this year will keep inflation moving lower. It still forecasts CPI to be close to 3 percent around mid-year, well below the January reading of 5.9 percent. And here the Bank offers  specific guidance as to what it will be focusing on: Year-over-year measures of core inflation ticked down to about 5%, and 3-month measures are around 3½%. Both will need to come down further, as will short-term inflation expectations, to return inflation to the 2% target.

The next few months are likely to be interesting times for the Bank, and not necessarily in a positive sense. If inflation indeed moves steadily lower and the economy grows only sluggishly, it will be difficult to justify ending the "conditional" pause. Concerns over excessive household indebtedness further add to the desirability of avoiding further rate hikes. 

However, the renewed signs of hawkishness at the Fed could severely limit the Bank's options. The overnight target is already below the Fed funds rate. A 50 basis point hike by the Fed on March 22, particularly if it is accompanied by strong indications of more such moves in the future, would likely put pressure on the exchange rate, which would soon translate into higher price pressures in Canada. For now, the Bank is likely minded to keep rates unchanged at its next Governing Council meeting, but by the time that meeting comes around (on April 12) it may be facing a very different situation.