Pause on

In line with market expectations (and with its own commitment to a "conditional pause" in policy tightening) the Bank of Canada today kept its overnight rate target unchanged at 4.5 percent. If the Bank's outlook for inflation over the remainder of the year proves accurate, it looks likely that there will be no further rate hikes in this cycle. Details of the Bank's forecast can be found in the updated Monetary Policy Report, also released today. 

The Bank notes that global economic growth has surprised to the upside in recent months, but expects the pace to slow as past monetary policy measures take full effect. In the US, it notes that recent strains in the banking sector will further tightening credit conditions, so that US growth is expected to slow considerably in the coming months, with particular weakness in sectors that are important for Canadian exports.    As for Canada, the Bank has also seen growth above its previous projections in recent months, but as past tightening measures kick in,  GDP growth is projected to be weak through the remainder of this year before strengthening gradually next year. This implies the economy will move into excess supply in the second half of this year. The Bank now projects Canada’s economy to grow by 1.4% this year and 1.3% in 2024 before picking up to 2.5% in 2025. 

The Bank's update inflation outlook is definitely bullish. It expects year-on-year CPI, most recently at 5.2 percent, to fall to 3 percent by mid-year -- that base effect again -- and then ease more gradually to reach the 2 percent target by year-end. The Bank will pay particular attention to service sector prices, inflation expectations and wage growth as it monitors the situation in the coming months. In terms of the last of these factors, it notes that wage growth is still elevated relative to productivity growth.-- and is also, at least for now, above the inflation rate. 

Given this analysis, the Bank's decision to prolong the conditional pause was clearly the appropriate one. March CPI data, due next week, are expected to show another sharp fall in the yearly rate, and while April's result may be pushed higher by the latest rise in global oil prices, there is little reason to think that the Bank's outlook for CPI will prove to be seriously inaccurate. The Bank warns that it remains prepared to raise the policy rate further if needed to return inflation to the 2% target , but it seems increasingly unlikely that this will in fact be needed. 

Of course, a major influence and constraint on the Bank's policy actions is the stance of the Federal Reserve.  US March CPI data, released this morning, have triggered market optimism that the Fed may also be able to pause its tightening measures.  Headline CPI rose only 0.1 percent in the month, dropping the year-on-year rate to 5.0 percent, the smallest rise since May 2021. That's good news, but the stickiness of core CPI (+0.4% m/m, +5.6% y/y) may convince the FOMC that it still has work to do. Barring another flare-up in banking sector tensions, a further 25 bp rate hike on May 3 would be do surprise.