The Bank of Canada decided to hold its key interest rate steady Wednesday but made clear it’s still prepared to raise rates further depending on how inflation and the economy progress.
The central bank’s policy rate remains at 4.5 per cent as of Wednesday.
The hold, which was widely expected by economists, comes after eight consecutive increases saw the key rate rise by 425 basis points since March 2 of last year. The central bank undertook one of the fastest rate tightening cycles in its history in hopes of tamping down rampant inflation.
Canada’s annual inflation rate has cooled from highs of 8.1 per cent in mid-2022 to 5.9 per cent as of January. Shorter-term measures of core inflation — a metric the Bank follows closely as it strips out more volatile price pressures — are also heading in the right direction as of late.
The Bank of Canada said in a statement accompanying the rate decision on Wednesday that the latest economic data is in line with its forecast calling for inflation to return to around three per cent by mid-2023.
Canada’s gross domestic product (GDP) data came in weaker than expected at the end of 2022, which was largely good news for the central bank. The Bank said in its statement that with weak economic growth expected in the quarters ahead, there should be less demand in the economy driving up prices.
Higher interest rates are working to discourage household spending, slow the economy and cool inflationary pressures, in the Bank’s view.
But the central bank added there are risks to the inflation outlook that could drive price pressures higher again and warrant another interest rate increase down the line.
The country’s “very tight” labour market and “surprisingly strong” employment growth are a significant source of uncertainty in its inflation forecast, policymakers wrote.
In addition, global factors such as Russia’s war in Ukraine and rebounding economic growth in China are risks that could drive inflation higher still.
The Bank of Canada reiterated in its statement that it “will continue to assess economic developments and the impact of past interest rate increases, and is prepared to increase the policy rate further if needed to return inflation to the (two per cent) target.”
Finance Minister Chrystia Freeland, speaking to reporters at an event in Mississauga, Ont., on Wednesday, acknowledged there will likely be “bumps” in the road getting inflation back to the Bank of Canada’s target.
“We’re not out of the woods yet,” she said. “Inflation is still too high and interest rates are really high and have gone up extremely fast. These are real challenges for Canadians.”
Freeland reiterated that she remains confident Canada is equipped to weather the economic slowdown affecting countries around the world and pointed to growing business opportunities with trading partners in Europe as one piece of evidence the country will emerge “terrifically positioned” from the current uncertainty.
What do economists expect to happen next?
Avery Shenfeld, chief economist at CIBC World Markets, said in a note to clients Wednesday morning that the Bank of Canada had to keep its wait-and-see approach because it doesn’t have enough data yet to say whether it needs to raise rates again or if it can firmly declare a peak for the current tightening cycle.
TD Bank senior economist James Orlando said in a client note Wednesday that the strong labour market, alongside financial supports from some levels of government in Canada, are “juicing the economy at a time when the BoC needs to see the opposite.
“Should this momentum continue, it could cause inflation to spike again, forcing the BoC back into hiking mode in the coming months,” he wrote.
The Bank of Canada’s hold on interest rates come as Jerome Powell, head of the U.S. Federal Reserve, hinted earlier this week that rates might need to rise higher yet south of the border.
But Shenfeld said that Wednesday’s decision and accompanying statement show the Bank of Canada is “going to keep its eyes on the home front” instead of following the Fed’s hawkish tone.
Some economists have flagged that a wider gap between terminal rates for the U.S. and Canadian central banks could translate to a weaker loonie amid a surging U.S. dollar.
RBC senior economist Josh Nye said in a note that markets had priced in higher odds of another hike from the Bank of Canada to keep pace with higher-than-expected rate hikes from European and U.S. central banks, “but today’s policy statement did nothing to endorse that view.”
The Bank of Canada’s next interest rate decision comes on April 12.