Interest rates on hold — for now. Where does the Bank of Canada go next?

The Bank of Canada left its benchmark interest rate unchanged at 5.0 per cent on Wednesday amid signs of cooling in the economy and easing in inflation.

The central bank warned that it is prepared to make additional hikes if needed, even as multiple economists predict the bank’s policy rate has likely hit its peak for this cycle.

Wednesday’s decision is the second time in a row the Bank of Canada held rates steady and was widely expected by economists and market watchers heading into the decision.

The central bank has rapidly raised its target for the overnight rate — a benchmark for other interest rates on loans like mortgages — by 4.75 percentage points since March 2022.

It’s done this to tamp down rampant inflation, raising the cost of borrowing for businesses and consumers alike and limiting Canadians’ spending power as more money goes towards paying down debt.

The Bank of Canada believes those past rate hikes are working, citing “growing evidence” that tighter monetary policy is “relieving price pressures” in Wednesday’s statement.

Overall inflation has indeed cooled significantly since the 40-plus-year highs seen last year, coming in at 3.8 per cent in September.

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But that’s still above the central bank’s critical two per cent target, and officials have expressed concern that the declines in inflation could stall before hitting that point.

The Bank of Canada warned that “progress towards price stability is slow and inflationary risks have increased” since it last released forecasts for inflation and the economy.

“We’ve made a lot of progress, but we’re not there yet. We need to stay the course,” Bank of Canada governor Tiff Macklem said in a speech on Wednesday.

In the release of an updated Monetary Policy Report on Wednesday, the Bank of Canada maintained its projections that inflation will cool to two per cent sometime in 2025. But it warned that persistence in core inflation and pressure from energy prices could keep inflation higher in the near term, forecasting inflation to hold around 3.5 per cent until mid-2024.

Policymakers are focusing on trends for cooling in core inflation, expectations for price increases, normalization in corporate pricing and wage gains in gauging the need for further rate hikes.

Among the biggest new risks in the Bank of Canada’s inflation forecast is the Israel-Hamas conflict. The monetary policy report noted that the war has not affected global oil supplies, but added that if the conflict spread regionally, such a disruption could force energy prices to rise in response.

Macklem told reporters on Wednesday that the Israel-Hamas conflict, as well as Russia’s ongoing invasion of Ukraine, a big risk in the central bank’s economic forecasts.

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He said these conflict are “causing incalculable human suffering.”

“They’re also hurting the global economy and adding uncertainty to the outlook,” he said.

“In a more hostile world, energy prices could move sharply higher and supply chains could be disrupted again, pushing inflation up around the world.”

RBC economist Claire Fan told Global News on Wednesday that it’s likely the central bank’s tightening cycle has peaked.

“We should be confident that inflation should continue to slow in the period ahead and ultimately … keep the Bank of Canada on the current hopeful pause that it is on right now,” she said.

The bar to raise interest rates again is “very, very high” now that the central bank is near its terminal rate, Fan argued.

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Additional hikes would require a “pretty substantial and persistent acceleration in inflation pressures,” she said, which doesn’t seem likely given all the slowing observed in Canada’s economy as of late.

A Reuters poll published Friday also indicates Bank of Canada is probably done raising rates and will hold them at at the current 22 year highs for at least six months.

Money markets now price in a 14 per cent chance of a rate hike at the next Bank of Canada decision on Dec. 6, according to Reuters.

Randall Bartlett, the director of Canadian economics at Desjardins, says that the central bank is looking to avoid a repeat of what happened earlier this year when it announced a “conditional pause” on rate hikes in January and the housing market roared back to life in the spring.

He told Global News in an interview that the Bank’s “hawkish” tone, which tilts towards more rate hikes rather than cuts, sends a message to Canadians that they “shouldn’t get ahead of themselves” assuming lower interest rates are imminent.

That said, Bartlett expects the Bank of Canada will be in position to start lowering rates by mid-2024, at which point the central bank should be more confident that a return to stable and predictable price growth is more of a certainty. Fan agreed that the middle of next year is the most likely timeframe for rate cuts based on today’s outlook.

Before Wednesday, economists had pointed to recent slowdowns in the economy and expectations for further cooling from businesses as reasons that price pressures will continue to ease in the months to come without need for further rate hikes.

The Bank of Canada also scaled down its expectations for economic growth in the coming year. It now expects real gross domestic product — a metric that acts as a stand-in for Canada’s economy — to grow 1.2 per cent annually this year, down from previous expectations for 1.8 per cent growth in the July forecasts.

Next year will also be worse in the central bank’s eye with real GDP expected to increase 0.9 per cent, down from previous calls for 1.2 per cent. The Bank sees the economy growing by 2.5 per cent in 2025.

Macklem said that the path to a soft landing — wherein the economy slows enough to cool inflation but does not fall into a recession — “has gotten narrower” since the Bank of Canada’s July projections.

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He said that the central bank is expecting economic growth to come in below one per cent for the “next several quarters,” with the chance for small contractions.

While a recession is typically defined by two or more quarters of negative GDP growth, Macklem said the central bank’s outlook is not calling for a recession like those seen throughout Canada’s history.

“When people say the word ‘recession,’ I think what they have in mind is a steep contraction in output and a large rise in unemployment. That’s not what we’re forecasting,” he said.

Desjardins is also expecting a “short, shallow recession” in the first half of 2024, Bartlett said Wednesday.

While he expects the downturn will be “broad-based,” with weakness felt across most sectors of the economy, he doesn’t expect a sharp rise in job losses. Employment could even rise somewhat next year, Bartlett ventured, but at a slower pace than the rapid gains seen across Canada’s labour market in recent years.

“This won’t be your mother or your grandmother’s recession,” he said.

“This is going to be something that’s really engineered by the Bank of Canada through higher interest rates to help bring the Canadian economy back down to balance.”

Macklem was asked Wednesday whether he thinks Canada is in for a bout of “stagflation” — a period of slowing growth, high prices and rising unemployment — given the central bank’s latest forecasts revised down expectations for GDP and raised the near-term inflation outlook.

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He disagreed with such an assessment, and said that, historically, 3.8 per cent inflation and an unemployment rate of 5.5 per cent are not really that high.

Macklem contrasted today’s economic landscape to that of the 1970s and 80s, when stagflation drove inflation, interest rates and eventually the unemployment rate into double digits.

Bartlett agreed with Macklem’s assessment, pointing to the country’s “very, very healthy” labour market.

“While, yes, inflation is higher than the Bank of Canada’s target and higher than certainly the bank is comfortable with, this is not an environment that’s akin to the 1970s or something along those lines,” he said.

— with files from Global News’ Nivrita Ganguly, Reuters