The Bank of Canada’s interest rate pause is set for its toughest challenge yet on Wednesday as policymakers weigh whether another hike is needed to quell a resilient economy and push inflation down further.
While money markets and some economists say that another hike is in the cards for this week’s interest rate decision, those who spoke to Global News argue the central bank is better off waiting to move off the sidelines and signalling a possible increase later this summer.
The Bank of Canada’s rate hike campaign has been on a “conditional pause” since March, following eight consecutive increases that raised the central bank’s policy rate to 4.5 per cent, up from the lows of 0.25 per cent seen through much of the pandemic.
The central bank said it could remain on pause as long as data continued to show the economy was cooling enough to bring inflation back down to its two per cent target, which has been forecast to reach in 2024.
The rate increases to date have raised the cost of borrowing for Canadians and their banks in an effort to cool the economy and take some of the steam out of inflation, which reached 40-plus-year highs in 2022.
Inflation has declined significantly, though Statistics Canada’s headline reading ticked back up slightly to 4.4 per cent in the latest consumer price index report for April from March’s 4.3 per cent.
The economy, meanwhile, has proved hotter than the Bank of Canada’s estimates: gross domestic product (GDP) was higher than forecast in the first quarter of the year, and expectations of a pronounced slowdown haven’t yet materialized.
Avery Shenfeld, chief economist at CIBC Capital Markets, tells Global News that the economy can only run unchecked for so long before a flurry of spending drives prices higher again.
“That’s why the Bank of Canada is now the traffic cop, thinking about giving us a ticket to slow us down,” he tells Global News.
Money markets see a nearly 40 per cent for a 25-basis-point hike on Wednesday, a more than 80 per cent chance for one by July, according to Reuters. They fully price one in by September.
Yet, about two-thirds of economists polled by Reuters last week expect the Bank to keep rates on hold for the rest of this year. Four said they see a hike on Wednesday and three-quarters said there is a risk of at least one increase in June or July.
Here’s why some economists and market analysts see Wednesday’s decision as a toss-up, and what could push the Bank of Canada to hike or to hold.
What’s changed for the Bank of Canada?
Randall Bartlett, director of Canadian economics at Desjardins, said that at the beginning of May, it was looking more and more like the Bank of Canada was in the clear to remain on hold.
Economists were “pretty confident” that the economy was showing signs of slowing and inflation was declining rapidly, by extension.
“All the stars were aligning for the Bank of Canada to stay on pause for a prolonged period of time,” he tells Global News.
Bartlett says that through the month of May, data was starting to show economic winds shift and blow against the central bank’s efforts.
After nearly a year-long correction, buyers returned to housing markets in many Canadian cities with bidding wars emerging over a limited supply of properties. And the Bank of Canada’s closely watched core inflation metrics remained “very, very sticky,” Bartlett says.
And then the GDP figures came in last week, which showed many Canadian consumers continue to spend freely despite pressures placed on them from higher interest rates.
The “clincher,” as Bartlett puts it, was Statistics Canada’s flash estimate for April showed modest growth from the economy; most observers had called for a decline amid an ice storm in central Canada and the public service strike in the month.
Despite these drags on growth, Canada’s economy and consumers have shown they won’t be reined in, he says.
“Underlying momentum in the Canadian economy remains very, very strong.”
Shenfeld says the Bank of Canada is also in a tough spot because of what the data hasn’t shown: any weakness in the labour market.
Canada’s unemployment rate has held steady at a low 5.0 per cent through all of 2023 so far, meaning most Canadians have been able to keep hold of their jobs and avoid any loss to income.
An uptick in the unemployment rate means more people lose their jobs, but it can also moderate wage inflation, which Shenfeld says is something the Bank will be looking to keep in check as it attempts to get price pressures all the way back down to two per cent.
“Simply put, that’s not been showing up in the data since they stopped raising interest rates,” he says. “And they might be starting to wonder whether interest rates are high enough to put the brakes on the economy in that way.”
Watching the Bank of Canada’s tone
The traditional wisdom in economics is that interest rate increases work on a lag — it’s only 12-18 months after a rate hike has been delivered that its impact has fully been absorbed into the economy.
These are among the reasons that, despite the economy showing little sign of weakness to date, Shenfeld believes Canada’s monetary policy “traffic cop” ought to let the economy off with a warning, rather than issue a ticket in the form of another hike.
Between Wednesday’s meeting and the Bank’s next decision on July 12, the Bank of Canada will get a few more data prints to see how the economy is faring under the weight of the rate hikes to date.
Two more Labour Force Survey releases will be released, giving a fresh look at how wages and employment is faring; the formal release for April’s GDP figures could show whether the flash estimate was as strong as first expected or perhaps a bit weaker; and inflation numbers will show if there’s been any progress on the “sticky” core inflation figures.
“My personal view is that the Bank of Canada should be a bit more patient,” Shenfeld says.
While markets have fully priced in another interest rate hike before the fall, Shenfeld says the Bank of Canada may also decide its policy rate is restrictive enough to bring inflation down, but that it will leave the higher rate in place for longer.
Leaving the benchmark interest rate on hold but giving a “stern warning” about more rate increases coming can actually act to stifle economic growth in and of itself, he adds, as Canadians plan for higher rates by spending less and fixed mortgage rates rise to anticipate the move.
“It almost acts like a brake on the economy even without raising the (policy rate),” Shenfeld says.
Bartlett, too, believes the Bank of Canada will strongly signal possible additional hikes on Wednesday, but not increase its policy rate just yet.
He notes that policymakers at the central bank are no strangers to surprises during this rate hike cycle. The Bank has left rates unchanged when oddsmakers bet on a hike, and increased by greater magnitudes than the consensus had expected as well.
But he also believes the Bank of Canada will have to do more to signal its intentions before moving off its pause. He expects the press release announcing the rate decision will be “hawkish” — leaning towards additional rate increases — and setting up a move in July if data released in June doesn’t align more closely to the Bank’s forecasts.
Bartlett says he expects the Bank of Canada will leave rates unchanged on Wednesday and hike by a quarter percentage point in July. If the economy remains persistent, another 25-basis-point step later in the year also is not off the table, he adds.
“If we continue to see strength in the labour market, the economy, elevated inflation, I think all of those are going to contribute to the Bank of Canada needing to put its foot back on the brake again.”
Statistics Canada will publish the next Labour Force Survey for May on Friday.
— with files from Reuters