Bank of Canada's Bold Move Against Inflation
On Wednesday, the Bank of Canada (BoC) announced that it had escalated its overnight rate to a staggering 22-year high of 4.75%. Immediately, both markets and analysts speculated an additional rise next month. This measure aims to curb a rapidly heating economy and persistently high inflation.
Fastest Monetary Tightening Cycle in History
Since January, the central bank has held off on adjustments to monitor the repercussions of previous increases. From March 2022 onwards, the bank had been intensifying borrowing costs, resulting in a speedy tightening cycle unprecedented in its history. The rate reached a 15-year high of 4.50%, with eight increases during this period.
Persistent Excess Demand in the Economy
The bank attributed the increase to stronger-than-anticipated consumer spending, a surge in service demand, a revival in housing activity, and a tight labor market. The central bank said these signs suggest that the economy's excess demand is proving more enduring than previously thought.
High Inflation: A Rising Concern
The BoC highlighted an inflation upswing in April, with three-month core inflation measures remaining at a stubborn high. This sparked concerns that the Consumer Price Index (CPI) inflation might remain significantly above the target of 2%. To restore the balance between supply and demand and bring inflation back down to the 2% target, the bank's governing council decided that the existing monetary policy was not sufficiently restrictive.
Canadian Dollar Strengthens Following Rate Hike
Following the announcement, the Canadian dollar appreciated by 0.4%, trading at 1.3350 to the US dollar. After reaching its most potent level in a month at 1.3322, money markets predict over a 60% probability of an additional rate hike in July, with expectations of further tightening by September.
Anticipating the Next Rate Hike
Scotiabank's Vice President of Capital Markets Economics, Derek Holt, anticipates a further 25 basis point increase in July. Likening the rate hikes to an irresistible bag of chips, Holt humorously commented, "It is like a bag of chips; you open one and just can't have one."
A Look Back at the Previous Peak
Notably, the last occurrence of a rate as high as 4.75% was back in April and May 2001.
Expectations for the Future and Previous Projections
Even though money markets and analysts anticipated a rate increase, many speculated it would likely occur at the next meeting in July. Approximately two-thirds of economists polled by Reuters last week predicted the central bank would maintain rates steady until the end of 2023.
Canadian Economy's Remarkable Resilience
The Canadian economy has demonstrated exceptional resilience through 2023, as emphasized by Andrew Kelvin, Chief Canada Strategist at TD Securities. Kelvin, who also anticipates a further hike in July, stated, "To lower demand, which is the bank's goal to achieve their 2% inflation target, we just need more tightening."
The Path Forward: Balancing Inflation
The BoC affirmed that it would keep scrutinizing economic indicators to ensure they align with achieving the inflation target. However, the bank dropped language indicating its preparedness to raise the policy rate to meet the inflation target, as stated in the April policy statement, rendering its next move more open-ended. The bank anticipates inflation slowing to 3% this summer but did not reaffirm that it would gradually reduce to the 2% target by the end of the following year as it had previously forecasted in April.
