Bank of Canada signals rates might have peaked. What comes next?

Click to play video: 'Bank of Canada holds key interest rate in 1st decision of 2024'
Bank of Canada holds key interest rate in 1st decision of 2024
WATCH: Bank of Canada holds key interest rate in 1st decision of 2024 – Jan 24, 2024

The Bank of Canada held its benchmark interest rate steady at 5.0 per cent on Wednesday and hinted that its tightening cycle might have peaked, but policymakers stayed mum on a possible timeline for rate cuts.

The decision, which marks the fourth consecutive hold from the central bank, was widely expected by economists.

Bank of Canada governor Tiff Macklem told reporters Wednesday that conversations at the central bank have shifted from debating whether interest rates are high enough to how long the central bank needs to keep rates at current levels.

The Bank of Canada has been raising the cost of borrowing since March 2022 in an effort to tamp down inflation, which has declined sharply from highs of 8.1 per cent. Annual inflation ticked up to 3.4 per cent in December from 3.1 per cent the month previous.

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Click to play video: 'Inflation jumps ahead of Bank of Canada interest rate decision'
Inflation jumps ahead of Bank of Canada interest rate decision

Macklem said that rate hikes to date have worked to relieve spending demand, but cautioned that rates could still rise further if inflation does not cooperate.

“Inflation is still too high, and underlying inflationary pressures persist,” he said. “We need to give these higher rates time to do their work.”

Spring rate cut is in the cards, economists say

Nathan Janzen, assistant chief economist at RBC, tells Global News that the shift in tone from Macklem on Wednesday reflects a growing “conviction” that the next move from the central bank is likely a rate cut, not another hike.

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After Wednesday’s rate hold and presser with Bank of Canada officials, most economists doubled down on their predictions for interest rate cuts to begin in April or June.

Desjardins and TD Bank are among forecasters calling for easing to begin in the spring, while RBC, CIBC and BMO are eyeing closer to mid-year for cuts. Money markets continue to fully price in a first, 25-basis-point cut in June, according to Reuters.

CIBC chief economist Avery Shenfeld said in a note to clients Wednesday that if inflation comes in below expectations, cuts starting in April are not off the table. CIBC is calling for a total of 150 basis points of rate easing this year, with the possibility the second cut from the Bank of Canada is half a percentage point.

Click to play video: 'Canada’s higher interest rates hitting low-income households harder than wealthy: StatCan'
Canada’s higher interest rates hitting low-income households harder than wealthy: StatCan

Revised forecasts in the Bank of Canada’s Monetary Policy Report (MPR) released Wednesday reaffirm the central bank’s expectations that inflation will hit its two per cent target in 2025.

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But Macklem warned that future declines in inflation will be “gradual and uneven,” suggesting that the path back to the two per cent target will be “slow.”

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Another interest rate hike is not in the Bank of Canada’s “base case,” Macklem said, but he said starting conversations about when the central bank can cut rates is still “premature” given ongoing risks to inflation such as high household debt levels and trade disruptions through the Red Sea.

“The progress has given us confidence that the rate is high enough; the unevenness, the persistence we’re seeing has us convinced that for now we need to hold where we are,” he said.

Macklem was asked Wednesday why he was not giving Canadians a clearer timeline for interest rate cuts.

“I worry that putting it on a calendar, it’s a false sense of precision. We’re going to have to see how inflation evolves,” Macklem said.

Shelter inflation a sticking point for Bank of Canada

Among the biggest standouts in inflation flagged by the Bank of Canada is shelter price inflation, which continues to run close to seven per cent annually. The central bank highlighted rising rents and costs for households renewing their mortgages as keeping pressures elevated here.

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Macklem was asked why the Bank of Canada is not dropping interest rates now if one of the sources of inflation is so closely tied to its own policy rate. He replied that while housing is an “important part of the economy,” it’s not the only source of inflationary pressure, with other parts of the consumer basket like food inflation also holding above the target.

Signs of underlying inflation elsewhere therefore reinforced the need to keep the policy rate at 5.0 per cent to keep downward pressure on prices, he said.

Bank of Canada senior deputy governor Carolyn Rogers was asked what impact, if any, the federal government’s planned cap on international students announced earlier this week would have on shelter inflation.

While Rogers said the central bank doesn’t comment on immigration policy, she said that Ottawa’s plans were “on their way to relieving” some of the pressure on the housing market from population growth.

Click to play video: 'Higher population levels can add to pressure on housing, Bank of Canada’s Rogers says'
Higher population levels can add to pressure on housing, Bank of Canada’s Rogers says

While the student cap could deliver some localized relief on rent prices in some cities and neighbourhoods close to schools, Janzen says it’s unlikely to offset the structural housing gap and growing population in Canada.

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“As far as moving the needle nationally, I think that the view is it’s most likely not significantly enough to impact the inflation numbers,” he says.

Rogers was also asked whether the Bank of Canada is concerned that announcing a likely peak in its rate tightening cycle will spur a rebound in the housing market that ultimately fuels inflation. The central bank announced a “conditional pause” in its rate hike campaign a year ago, which economists say helped to fuel a surge in the 2023 spring housing market.

She said that “an unexpected surge in housing prices … would put pressure on inflation,” but a substantial bump tied to a busier housing market this spring is also not in the Bank of Canada’s “base case.”

There are already some signs of life in Canada’s housing market amid an uptick in sales to end 2023.

TD Bank chief economist Beata Caranci told Global BC on Wednesday, however, that a possible housing resurgence may already be underway. Market expectations for interest rate cuts heading into Wednesday’s decision have already been driving down bond yields in recent months, which in turn feed into lower rate offers for fixed mortgages.

That phenomenon, which the Bank of Canada flagged as a risk in its updated MPR, improves affordability for would-be homebuyers and for those renewing their mortgages.

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“The minute we start to see mortgage rates come down, you already start to see an influx of demand coming back into the housing market,” Caranci said. The second half of 2024 could see “decent demand” drive an uptick in housing activity, she said, particularly if the Bank of Canada has started to cut rates by then.

Click to play video: 'Bank of Canada interest rate decision'
Bank of Canada interest rate decision

While those renewing their mortgages this year are still likely to see their monthly payments rise, Caranci said those homeowners are in a better position than those going through renewals this time last year or even in the fall.

Red Sea disruptions among risks to inflation

Though economic growth stalled through much of 2023, the revised MPR also shows the Bank of Canada expects the Canadian economy narrowly avoided a recession last year.

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While Statistics Canada data shows real gross domestic product contracted in the third quarter last year, the central bank predicts economic growth was flat in the final quarter, skirting the definition of a technical recession – two consecutive quarters of declines in GDP.

The Bank of Canada also highlighted attacks in the Red Sea tied to Israel-Hamas conflict as a possible risk to the inflation outlook. Global freight costs are rising as ships are forced to reroute around the Red Sea to avoid Houthi attacks.

If the conflict were to spread further, oil prices could “rise sharply” and prices for traded goods could also jump, the Bank of Canada argued in its forecasts. Further disruptions to trade in the region could “reverse some of the downward pressure on inflation that has come from improvements in supply chains,” the MPR read.

Click to play video: 'WEF summit: Freeland, Carney warn of future supply shocks amid global instability'
WEF summit: Freeland, Carney warn of future supply shocks amid global instability

While the Bank of Canada is projecting modest GDP growth in the first quarter of 2024, Janzen says a “significant bounceback” in the economy that reignites inflation would be cause for concern at the central bank.

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He pointed to the still-robust economy in the United States as having a significant say for how Canada’s economy performs in the months ahead. If U.S. activity remains strong and pulls its close trading partner up with it, Canada could get some economic tailwinds from south of the border.

Monetary policymakers in the States have also hinted more directly that multiple interest rate cuts could be in the cards for 2024, with the U.S. Federal Reserve’s first rate decision of the year set for next week.

While both central banks have independence to set their own policy rates, Janzen notes that the Bank of Canada will have to be careful how much it diverges from the path of its U.S. counterpart. The currency exchange rate between the two nations relies heavily on their respective policy rates, he says, and can intensify inflation on traded goods if they drift too far apart.

The Bank of Canada reiterated in its statement on Wednesday that it is watching the evolution of supply and demand in the economy, inflation expectations, corporate pricing behaviour and wage growth in deciding where to take its benchmark rate in the months ahead.

The central bank’s next interest rate decision comes on March 6, with its updated forecasts for inflation and the economy set for April.

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