Quick take

Bank of Canada caught between a rock and a hard place

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  • The Bank of Canada held its overnight rate at the effective lower bound of 0.25 per cent. The Bank Rate remained at 0.5 per cent while the deposit rate was also unchanged at 0.25 per cent.
  • Overall holdings of Government of Canada bonds remain roughly constant as the Bank continues its reinvestment phase.
  • The Bank continues to expect CPI inflation to remain high in the first half of 2022 but ease closer to 2.0 per cent in the second half of the year.
  • The Bank made no changes to its forward guidance. The Bank will leave the policy interest rate at its effective lower bound until economic slack is absorbed and the 2.0 per cent inflation target is sustainably achieved. The latest projections by the Bank show that the first interest rate hike is not likely to happen until “sometime in the middle quarters” of next year.

Key insights:

  1. Economic data are giving the Bank of Canada mixed signals. Supply chain disruptions continue to hamper the Canadian economy’s recovery, and the output gap is nowhere near closing. The latest GDP data show that output is still roughly 1.5 per cent below its level in the final quarter of 2019. Meanwhile, the labour market tells a different story. With the addition of 153,700 jobs in November, total employment is now 1.0 per cent above its pre-pandemic (February 2020) level. Total hours worked have also returned to their pre-pandemic levels.
  2. Meanwhile, the Omicron variant is making things even more complicated. The impact of the new variant on economic recovery and the near-term outlook is uncertain. Though we don’t expect widespread lockdowns, the new variant could disrupt global supply chains even further and push inflation higher. It could also hurt consumer and business confidence, hampering near-term economic growth.
  3. The Canadian labour market recovering faster than the U.S. labour market is not enough for the Bank of Canada to raise rates before the U.S. Federal Reserve. Canadian household debt is on average much higher than the U.S, which will prompt the Bank to think twice before raising rates too soon. Besides, Canadian real estate demand and prices have remained stubbornly high. Accounting for the headwinds and tailwinds facing the Canadian economy, we expect the Bank to wait until June next year to raise rates.

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Sasan Fouladirad

Sasan Fouladirad


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