The Bank of Canada today raised its target for the overnight rate to 2½%, with the bank rate at 2¾% and the deposit rate at 2½%. The bank is also continuing its quantitative tightening (QT) policy.
Inflation in Canada is higher and more persistent than the Bank expected in its April Monetary Policy Report (MPR), and is likely to remain around 8% for the next few months. While global factors such as the war in Ukraine and ongoing supply disruptions were the biggest drivers, domestic price pressures from excess demand are becoming more prominent. More than half of the components that make up the CPI are now up by more than 5%. With this widening of price pressures, the Bank’s core measures of inflation rose to between 3.9% and 5.4%. In addition, surveys show that more consumers and businesses expect inflation to be higher for longer, raising the risk that higher inflation will harden into price and wage setting. If this happens, the economic cost of restoring price stability will be higher.
Global inflation is higher, reflecting the impact of Russia’s invasion of Ukraine, continued supply constraints and strong demand. Many central banks are tightening monetary policy to fight inflation, and the resulting tighter financial conditions are slowing economic growth. In the United States, high inflation and rising interest rates are contributing to a slowdown in domestic demand. China’s economy has been held back by waves of restrictive measures to contain outbreaks of COVID-19. Oil prices remain high and volatile. The Bank now expects global economic growth to slow to around 3½% this year and 2% in 2023, before strengthening to 3% in 2024.
Additional excess demand has built up in the Canadian economy. Labor markets are tight with record low unemployment, widespread labor shortages and increasing pressure on wages. When demand is strong, businesses pass on higher input and labor costs by raising prices. Consumption is stable, driven by reimbursement for hard-to-reach services. Business investment is solid and exports are boosted by higher commodity prices. The bank estimates that GDP grew by about 4% in the second quarter. Growth is expected to slow to around 2% in the third quarter as consumption growth slows and housing market activity recedes after unsustainable strength during the pandemic.
The Bank expects Canada’s economy to grow by 3½% in 2022, 1¾% in 2023 and 2½% in 2024. Economic activity will slow as global growth slows and tighter monetary policy takes hold path in the economy. This, combined with the resolution of supply disruptions, will bring supply and demand back into balance and ease inflationary pressures. Global energy prices are also expected to decline. The July forecast sees inflation starting to ease later this year, easing to around 3% by the end of next year and returning to the 2% target by the end of 2024.
With the economy clearly in excess demand, inflation high and expanding, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to force the way to higher interest rates by raising the key rate by 100 basis points today. The Governing Council continues to assess that interest rates will need to rise further and the pace of increases will be guided by the Bank’s current assessment of the economy and inflation. Quantitative tightening continues and complements increases in the prime rate. The Governing Council is resolute in its commitment to price stability and will continue to take the necessary actions to achieve the 2% inflation target.
Information note
The next scheduled date for announcing the overnight rate target is 7 September 2022. The Bank will publish its next full outlook on the economy and inflation, including risks to the forecast, in the MPR on 26 October 2022.
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