The Bank of Canada holds the Overnight Rate at 4.5 per cent

The Bank of Canada kept its target for the overnight rate at 4.5 per cent, with the Bank rate at 4.75 per cent and the deposit rate at 4.5 per cent.

The Bank is continuing with its quantitative tightening, which started 11 months ago. Since the last announcement in late January, the Bank’s Government of Canada bond holdings have declined from around $368 billion to roughly $351 billion.

CPI inflation for January came in at 5.9 per cent on the year, with the Bank’s average of core inflation measures easing to about 5 per cent on the year. The Governing Council has indicated its intentions to keep rates fixed at their current level. However, this is conditional on economic developments moving in line with outlooks.

Real GDP growth was flat in the fourth quarter and came in below Bank expectations, largely due to a slowdown in inventory investment. Despite a weaker than expected close to 2022, the Bank believes data remains in line with projections and that inflation will moderate within 2023.

Key Insights

As we had expected, the Bank has kept rates unchanged. Despite the stickiness in inflation (excluding food and energy) and the lagged effects of interest rate hikes taking form, we see this as a prudent move by the Bank. Holding steady will allow the full effects of past hikes to be realized without over-ratcheting. Going forward, the Bank will likely keep a close eye on business investment and housing investment (both of which contracted in Q4 of last year), business production, household savings, and core inflation with hopes of the stickiness abating. Globally, the Bank is also likely to closely watch the actions of the U.S Federal Reserve, which is taking a relatively more hawkish stance compared to the Bank of Canada.

High interest rates are making it increasingly difficult for Canadians to fulfil their loan obligations. The average household debt-servicing ratio continues to increase. Those households who opted for variable rate loans in 2021 – expecting persistently low rates – are especially at risk. Total insolvencies have risen by 33.7 per cent on the year, with businesses insolvencies increasing by 55.4 per cent. While insolvencies may help tackle inflation by stifling demand pressures, they also pose a danger to supply. In November 2022, the number of active businesses declined as more than 4,000 firms exited various business markets. Those remaining highlight ongoing worries ranging from rising costs of intermediary goods to employee recruitment and retention. With the full impact of interest rate hikes yet to be felt in the economy and no expectations of rates dropping in 2023, the coming months may prove difficult for many businesses and households.

China’s reopening poses a risk to the Bank of Canada’s inflation control efforts. With China gradually lifting COVID-19 restrictions, the country’s factory activity has grown significantly since December 2022. This growth, as indicated by the official manufacturing purchasing managers’ index, is expected to lead to increased production demands, which could stimulate supply chains and ease inflationary pressures. However, increased demand for intermediary goods could also put upward pressure on Canadian goods’ prices, as China is Canada’s second-largest trading partner, importing over US$22B in 2022 across a variety of goods. With a tight labour market, such inflationary demand-side pressures on domestic goods’ prices could work against the Bank of Canada’s efforts to reduce inflation to its target range of 1-3 per cent. Depending on the severity of the effect in the short-term, the Bank may be forced to delay bringing interest rates down.