Bank of Canada Governor Tiff Macklem said Wednesday the economy is “just about as likely” to fall into a short-lived recession as it is to keep growing over the coming quarters.
His comments came after the central bank raised its key interest rate by half a percentage point on Wednesday, a smaller step than economists and markets had expected but still above the standard 25-basis-point increase.
The move marks the sixth consecutive rate hike by the central bank this year. Since March, the Bank of Canada has raised its key interest rate to 3.75 per cent from 0.25 per cent, making it more expensive for Canadians and businesses to borrow money.
The Bank of Canada signalled Wednesday more rate hikes are likely as the bank works to get inflation back to its target of two per cent.
The rate hike accompanied an updated Monetary Policy Report (MPR) from the central bank which forecast a slower growing economy than first expected. The Bank of Canada now anticipates growth of roughly one per cent next year and two per cent in 2024 as the economy rebounds.
But Macklem noted in a press conference Wednesday morning that growth is expected to “stall” over the next three quarters. “In other words, growth close to zero,” he said.
Asked to expand on whether the central bank still expects to hit a “soft landing” — the point at which the economy contracts enough to tame inflation but not tip into a recession — Macklem said the call for zero growth means there are risks that some quarters are negative and some are positive.
Typically, a recession in Canada and many other parts of the world is considered to be two or more consecutive quarters of negative growth.
“It’s just about as likely that we get some small negatives as we get some small positives,” Macklem said Wednesday.
But he added afterwards that if Canada does tip into recession territory, it “won’t be a severe contraction,” expecting the economy to bounce back starting in the second half of 2023.
“That might be as close as the central bank will come to calling a recession until we’re actually in one,” said Josh Nye, senior economist at RBC, in a note Wednesday.
Nye noted that RBC was in the minority of economists still calling for a half-percentage-point hike on Wednesday, and cited “a deteriorating global backdrop, slowing domestic growth, early signs of a softening labour market, and faster-than-expected decline in headline inflation” as justifying the decision.
The bank’s smaller-than-expected rate hike on Wednesday reflects the reduced economic outlook, said Benjamin Reitzes, BMO managing director of Canadian rates and macro strategist, in a note to clients.
“The Bank of Canada surprised markets, but a weakening economic backdrop suggests this ultimately could be the right move,” Reitzes said.
“Unfortunately, inflation is still red-hot and has shown no real signs of cooling yet.”
“That’s the fine balance the BoC is trying to achieve, threading the needle of taming inflation while not putting too much pressure on the economy. Today’s decision puts a bit more emphasis on the economy. Hopefully that doesn’t come back to haunt them in 2023 if inflation remains stickier than expected.”
What’s happening with inflation?
While overall inflation slowed to 6.9 per cent last month as gas prices fell, the central bank said its preferred measures of core inflation are “not yet showing meaningful evidence that underlying price pressures are easing.”
Macklem said that while there are early signs that higher interest rates are starting to cool price pressures, the economy is still running too hot to let supply catch up to consumer demand.
The bank signalled more rate hikes are needed to get inflation back to its target of two per cent. It expects inflation to come down to three per cent by the end of next year and back to two per cent by the end of 2024.
The MPR said that spending is starting to slow on “big-ticket items” like automobiles and furniture and the cooling is soon expected to spread to services. Travel, hotels and restaurant dining are among the areas expected to take a hit, the report said.
And while grocery store prices have been especially high — rising 11.4 per cent last month despite overall inflation cooling — the Bank of Canada said agricultural product prices and global supply chain bottlenecks that were previously identified as fuelling inflation have “tapered off.”
“These forces are expected to pass through to lower food and goods price inflation in the months ahead,” the bank wrote.
Economist Tu Nguyen with RSM Canada noted in a statement Wednesday that the bank’s decision to raise the policy rate just half a percentage point is “risky” with the U.S. Federal Reserve widely expected to raise rates 75 basis points at its decision next week.
She explained that since the Canadian dollar gets a boost from higher interest rates, the Bank of Canada falling off from the Fed’s pace could see the loonie depreciate even further from the surging U.S. greenback.
That could fuel higher inflation on imports from the U.S. heading into the colder winter months, she warned.
Bank of Canada Deputy Governor Carolyn Rogers responded to concerns about the loonie alongside Macklem at the press conference Wednesday, saying assumptions of a weaker Canadian dollar are built into the central bank’s latest inflation forecasts.
Where do interest rates go from here?
Macklem said the bank’s policymakers will be watching consumer spending patterns, the state of the global supply chain and the trends for inflation and inflation expectations to determine how high rates will still need to go.
“This tightening phase will draw to a close. We are getting closer but we’re not there yet,” he said.
The governor also defended the Bank of Canada as politicians from both sides of the aisle lament the pain of rising interest rates on Canadians.
While Conservative Leader Pierre Poilievre has gone as far as calling for Macklem’s removal during his leadership campaign, NDP Leader Jagmeet Singh has recently called the bank’s mandate into question for not sufficiently protecting workers’ jobs.
Liberal Finance Minister Chrystia Freeland, meanwhile, has defended the bank’s independence as critical for “institutional stability.”
Macklem conceded that higher interest rates are adding to the financial burden of Canadians already struggling with surging price growth, but was firm on the central bank’s mandate to bring inflation back to manageable levels.
“We also know adjusting to higher rates is difficult for many Canadians. We are watching that impact very closely. But unfortunately there is no easy out to restoring price stability,” he said.
Macklem noted that the risk of undershooting how high rates should be now and having to catch up later could leave households facing a “severe recession to control inflation.”
“Nobody wants that,” he said.
“These are difficult decisions. The independence of the central bank becomes more important when the decisions are difficult.”
With one interest rate decision left this year, RBC’s Nye predicts the Bank of Canada will deliver a 25-basis-point increase and leave its policy rate at 4.0 per cent, but he didn’t rule out another half-point hike in December.
Reitzes agrees with Nye’s 25-basis-point call for December but believes the central bank won’t stop there, pencilling in another quarter-point increase in January 2023 for a terminal rate of 4.25 per cent.
The Bank of Canada’s final interest rate decision of the year comes on Dec. 7.