The head of the Bank of Canada poured water on market expectations for interest rate cuts in 2023 as the central bank maintained its key policy rate on Wednesday.
The Bank of Canada held its benchmark interest rate at 4.5 per cent in a second consecutive decision, a move largely in line with economists’ expectations.
Though the Canadian economy has been off to a hot start, the central bank’s policymakers signalled that stronger than expected GDP growth and a tight labour market haven’t disrupted the Bank’s forecasts for inflation to cool to around three per cent by the middle this year.
Tiff Macklem, the Bank of Canada’s governor, told reporters Wednesday that Canadians can expect “welcome relief” on the inflation front after years of rampant price acceleration.
Annual inflation has cooled in recent months — down to 5.2 per cent in February from its 8.1 per cent peak in June — following a rapid increase in the Bank of Canada’s policy rate, aimed at raising borrowing costs and discouraging spending from Canadians.
Macklem signalled that while food inflation has continued to clock in around 10 per cent, the Bank of Canada is expecting prices for grocery shoppers to normalize in the months ahead as production and distribution costs ease.
But the central bank head also warned that interest rates could rise again to bring inflation back down to the Bank’s two per cent target.
While inflation has been on a downward trend globally amid an easing in gas prices, Macklem said possible stickiness in services inflation as a factor that could keep price pressures high.
Canada’s tight labour market and continued demand for services is continuing to push prices higher here, he said, adding that annual wage growth at upwards of five per cent is also too high to see inflation meaningfully come down.
Macklem told reporters that the forecasts built into money markets for interest rates to come back down before the end of 2024 is a bit premature, as the Bank of Canada projects it will take longer for interest rates to cool inflation on the services side.
“The implied interest rate cuts that are built into the market curve later this year don’t look like the most likely scenario to us,” he said.
Money markets are now pricing in 25 basis points of easing by the end of the year, according to Reuters, down from 35 basis points before the interest rate decision.
But some economists say the Bank of Canada was striking a “hawkish” tone on Wednesday, meaning it leans more towards future rate hikes than cuts.
“I think they (BoC) are worried that they’ve stalled out in terms of progress toward achieving two per cent inflation and the bias is that perhaps they need to do more,” said Derek Holt, vice president of capital markets economics at Scotiabank.
BMO chief economist Doug Porter said he sees the Bank of Canada in a “holding pattern” after Wednesday.
“We continue to expect the Bank to remain on hold until the end of 2023 before rate cuts begin in earnest in 2024,” said BMO chief economist Doug Porter in a note to clients.
Impacts from banking turmoil, federal budget
Carolyn Rogers, the Bank of Canada’s senior deputy governor, spoke about the impact on the Bank’s decision marking of recent banking collapses in the U.S. and Europe alongside Macklem on Wednesday.
While she said that the “immediate stress” from the banking turmoil appears “contained,” she said the global banking sector is seeing a “pullback” in lending that will weigh on economic growth.
In its quarterly monetary policy report also released Wednesday, the central bank’s updated forecasts suggest it expects the economy to still slow, just a little later than previously anticipated.
When asked whether a recession this year could be ruled out, Macklem said: “Our baseline forecast is for positive but weak growth and declining inflation.”
The new forecasting document dropped language from January saying there was a chance for “a couple of quarters with slightly negative growth.”
It’s now expecting real gross domestic product to grow by 1.4 per cent this year, up from its previous forecast of 1.0 per cent.
For 2024, the Bank of Canada revised growth to 1.3 per cent, down from 1.8 per cent.
Asked about the impact of the federal government’s 2023 budget released at the end of March, Macklem downplayed the effects of Ottawa’s spending plans on the inflation outlook.
Factoring in spending plans from the provinces as well as from measures announced in the 2023 budget such as the GST/HST credit top-up, the Bank of Canada is adding an additional $25 billion in government spending to its forecasts.
But since the federal government’s spending plans are roughly in line with expected economic growth over the same timeframe, Macklem said he does not expect the budget to significantly fuel inflation.
“Government spending plans are not contributing to slowing of growth that you see in our projection,” he said. “But at the same time, they’re not standing in the way of getting inflation back to the two per cent target.”
— With files from the Canadian Press, Reuters
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