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Bank of Canada Stays On Hold Amid “Uneven” Inflation Progress

As had been almost universally-expected, the Bank of Canada left its benchmark overnight rate unchanged this morning, but language in Governor Macklem’s statement tilted in a slightly more hawkish direction than market participants had anticipated, helping to boost the exchange rate.

In prepared remarks released ahead of the post-decision press conference, Governor Tiff Macklem said “Today’s decision reflects Governing Council’s assessment that a policy rate of 5 percent remains appropriate. It’s still too early to consider lowering the policy interest rate”. “Looking ahead, we continue to expect inflation will be close to 3 percent through the middle of the year before easing in the second half. Gasoline prices are expected to continue to add volatility to inflation in coming months, and shelter price pressures are likely to persist. In other words, the path back to our 2 percent target will be slow, and progress is likely to be uneven”.

“Risks to global energy prices and transportation costs related to conflicts remain elevated,” he warned. “Domestically, inflation could prove more persistent than expected. We don’t want to keep monetary policy this restrictive for longer than we have to. But nor do we want to jeopardize the progress we’ve made in bringing inflation down”.

In the statement itself, policymakers – like us – took a dim view of underlying growth momentum, noting that a hotter-than-expected fourth quarter gross domestic product report concealed signs of weakness, as the economy’s “pace remained weak and below potential”. “Final domestic demand contracted with a large decline in business investment” they said, while “a strong increase in exports boosted growth”. “Employment continues to grow more slowly than the population, and there are now some signs that wage pressures may be easing. Overall, the data point to an economy in modest excess supply”.

Officials preserved a final paragraph saying, “The Council is still concerned about risks to the outlook for inflation, particularly the persistence in underlying inflation. Governing Council wants to see further and sustained easing in core inflation and continues to focus on the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour”.

The Canadian dollar is climbing against the greenback as investors reduce the implied likelihood of rate cuts in the front half of the year. We suspect this could accelerate in the run-up to the April policy meeting, with a cautious bias likely to remain embedded when the Bank delivers its updated Monetary Policy Report – even as underlying economic fundamentals continue to worsen.

Key monetary policy variables, %

In prepared testimony released ahead of this morning’s appearance in front of the House Financial Services Committee, Jerome Powell warned markets against expecting a swift easing in benchmark interest rates. The Federal Reserve chair acknowledged it “will likely be appropriate to begin dialling back policy restraint at some point this year”, but followed closely in his colleagues’ footsteps in noting that “ongoing progress toward our 2 percent inflation objective is not assured. Officials will need “greater confidence that inflation is moving sustainably to 2 percent,” he said, before policy can begin to move in a more accommodative direction.

The impact on markets was relatively mild: traders who had been braced for a more hawkish message were left underwhelmed, and odds on an upward adjustment in the “dot plot” summary of economic projections at the Fed’s March meeting firmed only incrementally.

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