The Bank of Canada’s policymakers said they are still prepared to raise their benchmark interest rate further even as they hiked rates to their highest level in 22 years earlier this month.
The central bank on Wednesday released notes of the deliberations surrounding its interest rate decision on July 12, which saw the policy rate rise 25 basis points to 5.0 per cent.
The Bank of Canada’s July hike followed another quarter-percentage-point increase to the policy rate in June. Many economists at that time predicted a single rate hike would not have been sufficient to satisfy the central bank’s concerns that the decline in inflation could stall.
Debate ensued among observers and economists following the July 12 decision over whether the latest rate hike was really needed as inflation fell into the central bank’s one-to-three per cent target range.
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The central bank governing council’s consensus in July was that leaving the key policy rate unchanged at 4.75 per cent would risk stalling the progress it had made in tamping down price increases, which has so far seen annual inflation cool to a low of 2.8 per cent from highs of 8.1 per cent last year.
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But the “underlying inflation pressures” are proving “more persistent than expected,” policymakers expressed earlier this month. At the time of the July rate decision, more than half of the items in Statistics Canada’s consumer price index basket were seeing prices rise more than five per cent annually, the deliberations note.
Policymakers also flagged that “downward momentum in headline inflation was waning” and measures of core inflation, which strip out more volatile measures such as prices for gas and food, were showing signs of holding around 3.5 to 4.0 per cent.
Inflation could even rise again if the Bank of Canada did not continue to put pressure on the economy through higher rates, the governing council decided.
The governing council said that not acting forcefully enough to rein in inflation now could mean the central bank has to raise rates much higher later; conversely, if it raises the policy rate too high now, it risks making things “more painful than necessary” for Canadians.
“The consensus among members was that the cost of delaying action was larger than the benefit of waiting,” the deliberation notes read.
How the Bank of Canada is deciding where to go next
The central bank’s policymakers said that Canada’s labour market continues to show signs of tightness and household savings are still above pre-pandemic levels, which is continuing to fuel “excess demand” in the economy.
In the Bank of Canada’s surveys of businesses and consumers, short-term expectations for inflation are easing but remain elevated. Businesses continue to expect more frequent and substantial price increases as well, something the governing council flagged as needing to “normalize” before the inflation fight is over.
In preliminary discussions of where to take the key rate next and how to communicate its messaging, policymakers opted to leave future rate decisions up to a meeting-by-meeting basis.
“They agreed they were prepared to raise the policy rate further if inflationary pressures did not ease as projected and progress toward the (two per cent) target stalled,” the deliberations read. “But they did not want to do more than they had to.”
The Bank of Canada’s next interest rate decision is set for Sept. 6.
BMO senior economist Robert Kavcic said the deliberations did not reveal anything new about the July 12 decision, but does spell out the conundrum the Bank of Canada finds itself in.
“So, here is basically what the Bank is grappling with right now,” he wrote in a note to clients on Wednesday. “Either policy isn’t tight enough; or it is, but hasn’t been tight enough for long enough.”
While BMO is not expecting any further rate hikes this year, Kavcic wrote that the risks are weighted towards further tightening if the economic forecast doesn’t pan out to the Bank of Canada’s liking.
In an updated outlook released at the same time as the rate decision in July, the central bank called for inflation to hold around the three per cent market for the next year before dropping down to the two per cent target by mid-2025.
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