Bank of Canada Ups Key Overnight Rate
The Bank of Canada (BoC) made a significant move on Wednesday by increasing its key overnight rate by a quarter of a percentage point, pushing it to a staggering 5.00%. This is the highest it has been since 2001. The central bank's concern is rooted in excess consumer spending, which could potentially derail efforts to keep inflation to the targeted 2%.
The Impact of Increased Borrowing Costs
The decision to boost borrowing costs by 25 basis points is the second hike in two consecutive months, much in line with analysts' and markets' expectations. The BoC broke its five-month hiatus in June, when it upped the overnight rate, stating that the monetary policy wasn't sufficiently restrictive.
Revising Growth Forecasts and Inflation Target
In its recent statement, the BoC no longer mentioned rates being insufficiently restrictive, but it did revise its growth forecast for the year. The bank also delayed its inflation target expectations by six months, now aiming for mid-2025. Persistent excess demand and core inflation measurements in the 3.5%-4% range over the past few months have heightened concerns about the Consumer Price Index (CPI) inflation exceeding the 2% target.
Market Response and The Strengthening Canadian Dollar
In response to this rate hike, Canadian money markets placed higher bets on another imminent increase, projecting rates at 5.14% by December. The Canadian dollar also experienced an uptick, strengthening to 1.3157 against the U.S. dollar—a 0.6% rise for the day.
Economic Resurgence Despite Previous Hikes
Despite having implemented nine previous rate increases—totaling 450 basis points since last March—the economy bounced back in May. A likely growth of 0.4% is forecasted for the month, following a stall in April. The BoC upgraded its prediction for the annualized quarterly growth in Q2 from 1.0% to 1.5% in April. A similar expansion of 1.5% is anticipated in the third quarter. Meanwhile, the real GDP growth for 2023 is projected at 1.8%, up from the April forecast of 1.4%.
Persistent Inflation and Forecast Changes
While the headline inflation slowed to 3.4% in May, a substantial decline from last year's peak of 8.1%, the BoC's core measures' three-month annualized rates have remained stubbornly high. Higher-than-expected housing costs, sustained demand, and a slower-than-anticipated decline in goods prices, excluding food and energy, are keeping the inflation rates elevated.
The central bank expects inflation to return to 2% by mid-2025. However, the precise timing remains uncertain due to the gradual trend of inflation toward the target. It's important to note that the last time the BoC's overnight target rate stood at 5.00% was back in March and April of 2001.
Rate Hike: Expectations Vs. Reality
Before the announcement, a Reuters survey of 24 economists revealed that 20 had predicted the central bank would boost rates by a quarter of a percentage point. Additionally, money markets had projected over a 70% chance of a rate hike before the formal announcement.
