The Bank of Canada Increased the Overnight Rate to 4.75 Per Cent

  • The Bank of Canada increased its target for the overnight rate to 4.75 per cent, with the Bank rate at 5 per cent and the deposit rate at 4.75 per cent.
  • The Bank is continuing with its quantitative tightening. Since the last announcement in April, the Bank’s Government of Canada bond holdings have declined from around ­­­­­­­­­$340 billion to around $323 billion in May.
  • CPI inflation in April reached 4.4 per cent. The Bank continues to expect that CPI inflation will ease to about 3 per cent within the summer. The Bank, however, is concerned that CPI inflation could become stuck above 2 per cent given excess demand persisting and three-month measures of core inflation between 3.5 and 4 per cent for several months.
  • GDP growth for the first quarter of 2023 was stronger than the Bank expected, coming in at 3.1 per cent. The Governing Council says it will continue to assess core inflation and CPI inflation outlooks while evaluating the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour to ensure they remain in line with the Bank’s inflation goals.

Key Insights

Canadian housing markets could spell trouble for the economy overall. Despite housing sales increasing by 11.3 per cent in April, Canadian housing prices have declined April year-over-year by 3.9 per cent. At the core of this are interest rates which have continued to sour the notion of housing affordability as mortgage holders have to pay more to service their debt. Applying additional pressure to housing is the sentiment of potential home buyers, which the high rates have also stifled. Seeing the cost of a home purchase as unmanageable, many potential buyers have opted to wait out the period of elevated cost instead of joining into it, which could further contribute to declines in home prices. This could harm economic activity as a decline in homeowner equity would hurt their options for refinancing if they needed liquidity and force some belt-tightening. Furthermore, if credit losses for issuers of loans were to rise, this could impact the availability and affordability of loans of all types, compounding any existing economic hardship. 

Summer could deliver an economic slowdown. Across Canada, provinces are already experiencing higher temperatures, leading to arid conditions and incidences of wildfires from east to west. This might be a taste of what is to come, as early forecasts for the summer season have many provinces leaning towards above-normal temperatures. The higher temperatures could impact economic activity across Canada in industries such as insurance, agriculture, finance, construction, and real estate. Higher temperatures can lead to droughts and lower crop yields, and poor air quality could lead to increased insurance claims and drops in productivity. Noteworthy is that higher temperatures are also linked to lower real estate activity. Home buying is seen in part as an outdoor activity as buyers often travel to visit properties and walk outside to inspect neighbourhoods or outdoor features. Higher temperatures discourage this as buyers are more inclined to stay indoors to avoid uncomfortable heat resulting in fewer purchases. Depending on the severity of temperatures, all these industries (as well as others) could be impacted, resulting in a slower summer for economic activity and output.

Fears of a recession could become a self-fulfilling prophecy. Despite some efforts to soften expectations, a Bank of Canada 2023 first-quarter survey showed that roughly half of the Canadian businesses said they foresee a mild recession over the next year, an attitude echoed in consumers. These concerns could bring about a recession faster if consumers and businesses play into them. For example, if consumers fear a recession, they may begin to brace for it, slowing down spending and increasing savings. Continuing the example, this could take the form of less spending at a local store which could result in a drop in revenue for the store leading to a layoff. With that person laid off, they would have less to spend and continue the cycle. While spending on goods and services is still high, if consumers’ attitudes were to change, we may see some acceleration toward an economic downturn.

Learn more from April 2023 release of Index of Consumer Confidence.