- The Bank of Canada increased its target for the overnight rate by 25 basis points to 4.5 per cent, with the Bank rate at 4.75 per cent and the deposit rate at 4.5 per cent.
- The Bank believes economic growth in Canada has been stronger than expected and that the economy remains in excess demand. However, there are signs that its restrictive monetary policy is slowing activity, especially household spending. The Bank estimates that the GDP grew by 3.6 per cent in 2022 but will fall to 1 per cent in 2023 and 2 per cent in 2024.
- Lower gasoline prices and durable goods have contributed to inflation, declining from 8.1 per cent in June to 6.3 per cent in December. Regardless, short-term inflation expectations remain elevated, with year-over-year measures of core inflation around 5 per cent.
- The Bank projects inflation to come down to around 3 per cent in the middle of this year and back to the 2 per cent target in 2024. This is driven by lower energy prices, improvements in global supply conditions and the effects of higher interest rates on demand.
- If economic developments remain as expected, the Governing Council expects to hold the policy rate at its current level and evaluate the impact of higher rates on the broader economy.
No reason for interest rates to rise further, given the outlook on inflation and economic growth. Today’s 25 basis point increase makes it the eighth consecutive time the Bank of Canada has raised the policy rate over the past year. On the one hand, the Consumer Price Index (CPI) has declined from its peak of 8.1 per cent in June 2022 to 6.3 per cent (y/y) last month. We expect inflation to reach the Bank’s target by December 2023. On the other hand, the negative impacts of higher interest rates are becoming more noticeable throughout the economy. Home prices, for example, are projected to correct by 18 per cent from peak to trough, further weakening demand and consumer spending. After today’s move, the Bank of Canada should take a wait-and-see approach to evaluate the broader impact of higher interest rates on the Canadian economy.
China’s re-opening could make the Bank’s job more difficult. China’s decision to dismantle its zero-Covid policy in December means a new wave of spending and economic activity is potentially on its way by the world’s second-largest economy. Although re-opening of the Chinese economy could mean additional easing of supply chain challenges, a new wave of demand would also put upward pressure on energy prices, and hence inflation. Any inflation imported to Canada would mean further pressure on the Bank to continue raising interest rates beyond what was originally expected.
The debt ceiling standoff in the United States could potentially have ramifications in Canada. South of the border, a partisan battle is forming surrounding the debt ceiling, which currently stands at roughly 120 per cent of the country’s real GDP. If there are no agreements in congress to raise the ceiling, the U.S. Department of Treasury would be forced to run down its Treasury General Account (TGA), a liability of the Federal Reserve, to cover its obligations. Running down the TGA would mean injecting liquidity into the system, the opposite of what the Federal Reserve wants to fight inflation. Although the period when the U.S. Treasury could potentially not meet all its obligations falls between July and September, the uncertainty surrounding the debt ceiling can cause increased premia on short-dated Treasury bills. This could cause investors to flock towards longer-dated Treasuries or short-term bonds from abroad, including Canada until the uncertainty fades.