In what could become its last move in this tightening cycle, the Bank of Canada lifted its benchmark overnight rate by a quarter percentage point to 4.50 percent this morning, while clearly setting the stage for a conditional pause at coming meetings. In the statement accompanying the decision, the central bank said “The Bank’s ongoing program of quantitative tightening is complementing the restrictive stance of the policy rate. If economic developments evolve broadly in line with the MPR (Monetary Policy Report) outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases”.
On inflation, officials noted that year-over-year measures of core inflation remained elevated, but highlighted a drop in 3-month measures, a development that suggests “core inflation has peaked”. Inflation pressures are seen subsiding “significantly”, with year-over-year price increases falling toward the Bank’s target by the middle of 2023. The annualized headline measure is seen dropping to 5.4 percent in the first quarter, down from the 6.7-percent pace hit in fourth quarter 2022.
Policymakers said “Labour markets are still tight: the unemployment rate is near historic lows and businesses are reporting ongoing difficulty finding workers,” but noted that higher rates were beginning to bite: “there is growing evidence that restrictive monetary policy is slowing activity, especially household spending. Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially”.
According to estimates published in the accompanying Monetary Policy Report, the economy grew faster than expected at the tail end of 2022, up 1.3 percent on a quarter-over-quarter basis, and will avoid contraction in the first three months of 2023, expanding 0.5 percent. Although “growth is expected to stall through the middle of 2023,” the projections point to a 1-percent expansion for the full year, effectively unchanged from the previous forecast.
The forward-looking context for the decision is important. After rates climbed by 425 basis points over the last year, signs of slowing economic momentum are evident across Canada. Debt servicing costs will keep climbing in the months ahead, the all-important housing market could continue its descent, and real consumer spending is very likely to continue falling.
The Canadian dollar slid roughly 50 basis points in the moments after the announcement. Traders were well prepared for the substance of the decision itself, but few expected officials to clearly define a halt to hiking – and the dovish tilt in the statement language and accompanying Monetary Policy Report took some by surprise, demolishing odds on another quarter-point move in the months ahead.
The decision will likely serve to anchor US and global expectations slightly lower, partially nullifying the longer-term impact in foreign exchange markets, but longer-term interest rates suggest that investors remain convinced the Bank of Canada will begin cutting sooner—and more aggressively—than the Federal Reserve. Canadian two-year yields are 56 basis points lower than their US equivalents, while the ten year spread favours the US by 59 basis points.