Going into today's Bank of Canada interest rate announcement, a few analysts were predicting an immediate rate hike, but the consensus was for a kind of "hawkish hold" -- tough talk and the threat of rate hikes to come, but no actual move. In the event, the Bank boosted its overnight rate target by 25 basis points, bringing it to 4.75 percent, the highest since 2001. It also provided a lengthy explanation for its decision, leaving little doubt that there may be one or more further rate hikes to come.
The press release starts by placing Canada's inflation in its international context. It appears that the Bank believes that in the US and Europe as well as in Canada, the easy part of getting inflation back to target has now been achieved, but what remains to be done is set to be trickier:
Globally, consumer price inflation is coming down, largely reflecting lower energy prices compared to a year ago, but underlying inflation remains stubbornly high. While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability.
As for Canada, the Bank notes recent evidence that the economy is continuing to operate at a higher level than previously expected, despite the aggressive rate hikes seen over the past year.
Canada’s economy was stronger than expected in the first quarter of 2023, with GDP growth of 3.1%..... spending on interest-sensitive goods increased and, more recently, housing market activity has picked up. The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour. Overall, excess demand in the economy looks to be more persistent than anticipated.
In terms of inflation, the Bank is still expecting a significant decline in the very near term, but it worries about further progress after that:
CPI inflation ticked up in April to 4.4%, the first increase in 10 months, with prices for a broad range of goods and services coming in higher than expected......The Bank continues to expect CPI inflation to ease to around 3% in the summer, as lower energy prices feed through and last year’s large price gains fall out of the yearly data. However, with three-month measures of core inflation running in the 3½-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target.
What the Bank is in effect saying is that most of the welcome decline in inflation over the past year has been the result of the base effect, as outsized gains from early 2022 fall out of the year-on-year index, rather than a slowing in the running rate of inflation. Recent month-on-month data have been above the levels needed to get CPI back to the 2 percent target. This evidently justifies today's move in the Bank's opinion, and seems very likely to lead to at least one further 25 basis point move in the second half of the year -- if not at the mid-July fixed announcement date then certainly not long after.
It is still very much open to dispute whether the Bank's aggressive rate hikes have been the right remedy for the recent bout of inflation, which was triggered by supply chain issues that are unlikely to be affected by higher interest rates. Indeed, the immediate impact of this latest rate hike will be to push the shelter cost component of CPI, already a major contributor to the overall inflation rate, even higher.
The Bank is certainly well aware of this. It seems very possible that its decision to move rates today rather than delaying in line with the market consensus is based on a sneak peek at the May employment report, due to be released on Friday. It would be no surprise to see another outsized gain in employment, very possibly accompanied by a jump in wage gains. In fact, if that is not the case, it is unlikely that the Bank would have chosen to buck the market consensus, something it never really likes to do.
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