Bank of Canada Keeps Overnight Rate Unchanged Amid Uncertain Economic Outlook

Bank of Canada maintains key interest rate and continues quantitative tightening

Economic Outlook

The Bank of Canada announced today that it will maintain the target for the overnight rate at 5%. The bank rate remains at 5¼% and the deposit rate at 5%. Additionally, the Bank will continue its policy of quantitative tightening.

Globally, the economy is slowing down. It is anticipated that growth will further moderate as demand is constrained by past interest rate hikes by central banks and the recent surge in global bond yields. The Bank forecasts global GDP growth of 2.9% this year, 2.3% in 2024, and 2.6% in 2025.

While the global growth profile has remained largely unchanged since the July Monetary Policy Report, the U.S. economy is showing stronger performance than expected, while economic activity in China is weaker. Eurozone growth has also continued to slow down.

Inflation is decreasing in most economies as supply chain issues are resolved and weakened demand eases the pressure on prices. However, central banks remain vigilant due to persistent underlying inflation. Oil prices exceed the assumptions made in the July report, and the conflict in Israel and Gaza represents a new source of geopolitical uncertainty.

In Canada, a growing body of data indicates that past increases in the overnight rate are curbing economic activity and alleviating pressures on prices. Consumption has been modest, as evidenced by declining demand for housing, durable goods, and many services. Weakened overall demand and rising borrowing costs are weighing on business investment.

Demographic growth is both alleviating labor shortages in certain sectors and supporting housing demand and consumption. Job creation has been weaker than the recent growth in the labor force, and job vacancies have continued to decline. However, the labor market remains relatively tight, and wage pressures persist.

Overall, various indicators suggest that supply and demand are approaching equilibrium. Economic growth has averaged 1% over the past year and is expected to remain weak for another year before recovering towards the end of 2024 and in 2025. The short-term weakness reflects the increasing impact of past rate hikes and the slowdown in foreign demand. The anticipated recovery will be driven by household spending as well as a strengthening of exports and business investment due to improved foreign demand. A significant portion of the growth is expected to come from government spending over the projection period.

The Bank expects the Canadian economy to have an expansion rate of 1.2% this year, 0.9% in 2024, and 2.5% in 2025.

Inflation

Consumer Price Index (CPI) inflation has been volatile in recent months, with readings of 2.8% in June, 4.0% in August, and 3.8% in September. Higher interest rates are moderating the increase in prices of many goods typically purchased on credit, and similar effects are starting to be observed in services. The pace of food price increases is slowing down after maintaining a very high rhythm. However, in addition to high mortgage interest rates, rents and other housing costs continue to experience significant increases.

Short-term inflation expectations and the pricing practices of businesses are only slowly normalizing, and wage growth remains around 4 to 5%. The Bank’s preferred measures of underlying inflation show very little improvement.

According to the Bank’s October projection, CPI inflation is expected to average around 3.5% until mid-2024, then gradually decline to reach 2% in 2025. This return to the target essentially aligns with the projection made in July, except for the expectation that inflation will remain higher in the short term due to rising energy prices and persistent strong underlying inflation.

Monetary Policy Decision

Based on clearer signs that monetary policy is curbing spending and alleviating pressures on prices, the Governing Council decided to maintain the overnight rate at 5% and continue the normalization of the Bank’s balance sheet. However, it remains concerned about the slow progress towards price stability and the increasing inflation risks, and is therefore prepared to raise the overnight rate again if necessary.

The Governing Council wants to see underlying inflation on a downward trajectory and continues to closely monitor the balance between supply and demand, inflation expectations, wage growth, and business pricing practices. The Bank remains committed to restoring price stability for the Canadian population.

Conclusion

In conclusion, the Bank of Canada has decided to maintain the key interest rate at the current level and continue its policy of quantitative tightening. The global economy is slowing down, and inflation is decreasing in most economies. In Canada, past rate hikes have been curbing economic activity, but wage pressures persist. The Bank anticipates modest economic growth in the coming years, driven by household spending, exports, business investment, and government spending.

The Bank remains committed to monitoring the balance between supply and demand, inflation expectations, wage growth, and business pricing practices. It stands ready to adjust monetary policy further to ensure price stability for the Canadian population.

The next interest rate announcement is scheduled for December 6, 2023. The Bank will release its next full economic and inflation projection, along with an analysis of related risks, in the Report to be published on January 24, 2024.