Bank of Canada still sounds hawkish

As expected, the Bank of Canada raised its overnight rate target by a further 25 basis points today, bringing it to 5.0 percent. It's remarkable to note, especially for those of us old enough to remember the ultra-high interest rate era of the 1980s, that this is the highest the target has been since 2001. 

The press release is longer than usual and the Bank's take on the current situation is further fleshed out in an updated Monetary Policy Report.  In brief, the Bank sees that the Canadian economy has been growing more quickly than previously forecast, so excess demand and labour force tightness persist. Growth is expected to be slower over the next twelve months, but further progress in reducing inflation will be slow, with a return to the 2 percent target, previously hoped-for by sometime in 2024, now not expected until mid-2025. Some key quotes:

Regarding real growth: Canada’s economy has been stronger than expected, with more momentum in demand. Consumption growth has been surprisingly strong at 5.8% in the first quarter. While the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent retail trade and other data suggest more persistent excess demand in the economy.

Regarding immigration levels, a new topic for the Bank: Strong population growth from immigration is adding both demand and supply to the economy: newcomers are helping to ease the shortage of workers while also boosting consumer spending and adding to demand for housing.

Regarding inflation: Inflation in Canada eased to 3.4% in May, a substantial and welcome drop from its peak of 8.1% last summer. While CPI inflation has come down largely as expected so far this year, the downward momentum has come more from lower energy prices, and less from easing underlying inflation......CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in the January and April projections. Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability.

Given this analysis, today's rate hike was in effect a foregone conclusion:  In light of the accumulation of evidence that excess demand and elevated core inflation are both proving more persistent, and taking into account its revised outlook for economic activity and inflation, Governing Council decided to increase the policy interest rate to 5%...... we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Ahead of today's meeting, there had been some speculation that a rate hike this month would likely mark the end of the current tightening cycle. The tone of today's statement, and particularly the startling prediction that CPI will not return to the 2 percent target for another two years, makes that rosy outlook seem very unlikely.  Markets are now pricing in another 25 basis point hike at the Bank's September 6 Governing Council meeting. As always, the actual decision will depend on the data flow, but at this point it is hard to see any other outcome.