The Bank of Canada (BoC) today increased its target for the overnight rate to 5%, with the Bank Rate at 5.25% and the deposit rate at 5%. The Bank is also continuing its policy of quantitative tightening.
Canada’s economy has been stronger than expected, with more momentum in demand, that national bank said in its report. “Consumption growth has been surprisingly strong at 5.8% in the first quarter,” the BoC stated.
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. In addition, the housing market has seen some pickup. New construction and real estate listings are lagging demand, which is adding pressure to prices.
In the labour market, there are signs of more availability of workers, but conditions remain tight, and wage growth has been around 4-5%, according to the bank statement 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.
The bank’s July Monetary Policy Report (MPR) projects the global economy will grow by around 2.8% this year and 2.4% in 2024, followed by 2.7% growth in 2025.
As higher interest rates continue to work their way through the economy, the Bank expects economic growth to slow, averaging around 1% through the second half of this year and the first half of next year. This implies real GDP growth of 1.8% in 2023 and 1.2% in 2024. The economy will move into modest excess supply early next year before growth picks up to 2.4% in 2025.
Canada’s national bank says inflation in the country 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. With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation. Moreover, with three-month rates of core inflation running around 3½-4% since last September, underlying price pressures appear to be more persistent than anticipated. This is reinforced by the Bank’s business surveys, which find businesses are still increasing their prices more frequently than normal.
In the July MPR projection, 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.
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, the bank’s Governing Council decided to increase the policy interest rate to 5%.
Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. “In particular, 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 said.
The next scheduled date for announcing the overnight rate target is September 6.
