The Bank of Canada lifted its benchmark overnight rate by half a percentage point to 4.25 percent this morning, while telegraphing an imminent pause in its monetary tightening cycle. The decision surprised markets that had anticipated a smaller quarter point move – but softened the blow by lowering expectations further out.

In the statement accompanying the decision, the central bank said “growth in the third quarter was stronger than expected, and the economy continued to operate in excess demand,” observing that “Canada’s labour market remains tight, with unemployment near historic lows”.

Signs of a slowdown were flagged: “While commodity exports have been strong, there is growing evidence that tighter monetary policy is restraining domestic demand: consumption moderated in the third quarter, and housing market activity continues to decline. Overall, the data since the October MPR (Monetary Policy Report) support the Bank’s outlook that growth will essentially stall through the end of this year and the first half of next year”.

In discussing exogenous conditions, officials said “Global economic growth is slowing, although it is proving more resilient than was expected at the time of the October Monetary Policy Report,” observing that the US “economy is weakening but consumption continues to be solid and the labour market remains overheated”.

Inflation risks subsided but remained too high for comfort, prompting policymakers to say “three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum. However, inflation is still too high and short-term inflation expectations remain elevated”.

Perhaps most importantly, officials dropped their tightening bias, removing language that previously said, “The Governing Council expects that the policy rate will need to rise further”. In its place, the statement said the “Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target. Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding”.

The Canadian dollar jumped slightly higher in the moments after the decision. Most traders were looking for a smaller move, but conviction was relatively low and directional positions were minimal – and longer-term rates continue to point to persistently negative interest differentials: Canadian two-year yields are 57 basis points lower than their US equivalents, and the ten year spread favours the US by 76 basis points. Canada’s yield curve is the most inverted across major economies, suggesting that investors think inflation will be subdued and the economy will topple into recession in the months and years ahead.