As had been widely expected, the Bank of Canada held its benchmark overnight rate at 5 percent this morning, warning that “growing evidence that past interest rate increases are dampening economic activity and relieving price pressures”

Officials noted signs of slowing momentum across the economy, saying “Consumption has been subdued, with softer demand for housing, durable goods and many services. Weaker demand and higher borrowing costs are weighing on business investment,” and pointed to a welcome “approaching balance” in overall supply and demand.

According to updated forecasts contained in the Monetary Policy Report, the economy is expected to expand 1.2 percent this year—down from the 1.8 percent estimated in June—and 0.9 percent in 2024.

The statement noted that the “Bank’s preferred measures of core inflation show little downward momentum,” with inflation expectations and corporate pricing behaviour “normalizing only gradually,” and wage growth remaining elevated – but updated forecasts showed headline inflation running at 3.5 percent through the middle of next year before declining to 2 percent in 2025. In an almost-obligatory passage, the Bank warned “Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed”.

With an unchanged benchmark rate, a hawkishly-biased statement, and broad-based forecast downgrades largely priced in ahead of the decision, moves in Canadian markets this morning are being driven by an external rise in Treasury yields, not updated views on the Bank of Canada’s likely trajectory. Swap rates are moving slightly lower as rate cuts become more likely in 2024, but the bulk of the decline in the exchange rate came before the announcement as US ten-year yields pushed toward the 5 percent threshold yet again.

Looking ahead to December, we think policymakers will again try to balance hawkish rhetoric with a dovish outlook, but will ultimately fail to convince markets of more rate hikes in the offing. The risk of a profound downturn in Canadian economy – long far more sensitive to a rise in borrowing costs than its bigger southern counterpart – now outweighs the likelihood of a “melt-up” in inflation rates.