The Bank of Canada raised its benchmark overnight rate to 4.75 percent this morning, noting that “excess demand in the economy looks to be more persistent than anticipated,” and saying “monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2 percent target”.

In the statement-only decision, officials said the economy grew at a 3.1 percent annualized pace in the first quarter – beating consensus expectations and the central bank’s forecasts – while household spending remained elevated. “Consumption growth was surprisingly strong and broad-based, even after accounting for the boost from population gains. Demand for services continued to rebound”. Housing markets, which have an outsized impact on overall activity in Canada, showed signs of accelerating once again, along with spending on “interest rate-sensitive goods”.

The unemployment rate held at 5 percent in April, and the country added another 41,400 positions, marking an eighth consecutive month of positive job numbers. According to policymakers, “The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour”.

And price pressures heated up: “CPI inflation ticked up in April to 4.4 percent, the first increase in 10 months, with prices for a broad range of goods and services coming in higher than expected. Goods price inflation increased, despite lower energy costs. Services price inflation remained elevated, reflecting strong demand and a tight labour market”. Although policymakers expect inflation to subside somewhat over the summer as energy prices decline and base effects fade out of the data, the risk of stickiness is increasing: “with three-month measures of core inflation running in the 3½-4 percent range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2 percent target”.

Changes in forward guidance language were fairly neutral, with officials pledging to continue assessing “the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the inflation target”. Deputy Governor Paul Beaudry is expected to add more clarity in tomorrow’s speech and press conference.

With a summer hike largely priced in ahead of the decision, gains have been relatively limited: two-year yields inched higher and the Canadian dollar climbed almost 50 basis points in the moments after the announcement.

The Canadian economy has clearly proven far less sensitive to rising borrowing costs than many – including ourselves – had anticipated. Pandemic-era excess savings, the aftermath of a surge in refinancing activity, continued fiscal spending, and high immigration may be providing a buffer against weakness. But market participants remain wary of a longer-term downturn, and yield curves remain deeply inverted – meaning that rate differentials are providing limited support relative to the dollar.