Bank of Canada Holds Key Interest Rate Steady Amidst Economic Uncertainty

Bank of Canada Maintains Key Interest Rate, Continues Quantitative Tightening

Introduction

The Bank of Canada announced today that it will be keeping the target overnight rate steady at 5%. The official discount rate remains at 5.25% and the deposit rate at 5%. Additionally, the Bank will continue its policy of quantitative tightening. Globally, the economy is slowing down, and it is expected that growth will continue to moderate due to the effects of past central bank rate hikes and the recent surge in global bond yields. The Bank projects global GDP growth of 2.9% this year, 2.3% in 2024, and 2.6% in 2025.

Global Economic Outlook

While the overall profile of global economic growth has remained relatively stable since the release of the July Monetary Policy Report, the American economy has shown more vigor than anticipated, while economic activity in China has weakened. Eurozone growth has also slowed down. Inflation is decreasing in most economies as supply issues are resolved and weakened demand reduces price pressures. However, central banks remain vigilant due to persistently high underlying inflation. Oil prices have exceeded the assumptions made in the July report, and the conflict in Israel and Gaza represents a new source of geopolitical uncertainty.

Canadian Economic Outlook

In Canada, increasing evidence suggests that past interest rate hikes are slowing down economic activity and easing price pressures. Consumption has been modest, as evidenced by decreased demand for housing, durable goods, and many services. Weakened global demand and increased borrowing costs are weighing on business investment. Demographic trends are both alleviating labor shortages in certain sectors and supporting housing demand and consumption. Job creation has been weaker than the growth in the active population, and job vacancies have continued to decline. However, the labor market remains tight, and wage pressures persist.

Economic Balance

Various indicators suggest that supply and demand are now approaching equilibrium. Economic growth has averaged 1% over the past year and is expected to remain weak for another year before picking up towards the end of 2024 and in 2025. This near-term weakness reflects the growing impact of past rate hikes and the slowdown in foreign demand. The projected 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 growth is expected to come from government spending during the projection period. Overall, the Bank expects the Canadian economy to expand by 1.2% this year, 0.9% in 2024, and 2.5% in 2025.

Inflation Outlook

Measured by the Consumer Price Index (CPI), inflation has been volatile in recent months, reaching 2.8% in June, 4.0% in August, and 3.8% in September. Higher interest rates are moderating the rise in prices for many goods typically bought on credit, and this trend is also emerging in the services sector. The increase in food prices is slowing down after maintaining a high pace. On the other hand, in addition to high mortgage interest rates, rents and other housing costs still have a high rate of increase. Short-term inflation expectations and business pricing practices are only slowly normalizing, and wage growth remains around 4 to 5%. As for the Bank’s preferred measures of underlying inflation, they show little improvement. According to the Bank’s October projection, CPI inflation is expected to average around 3.5% until mid-2024 and then gradually decrease to reach 2% in 2025. This return to target essentially aligns with the projection made in July, with the expectation that inflation will now remain higher in the short term due to rising energy prices and persistent high underlying inflation.

Bank’s Decision and Concerns

Based on clearer indications that monetary policy is curbing spending and alleviating price pressures, the Governing Council has decided to maintain the key interest rate at 5% and continue to normalize the Bank’s balance sheet. However, the Council is concerned about the slow progress towards price stability and the increasing risks of inflation, and therefore stands ready to raise the key interest 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.

Upcoming Reports

The next date for the establishment of the target overnight rate is December 6, 2023. The Bank will release its next complete projection for the economy and inflation, as well as an analysis of related risks, in the Report to be published on January 24, 2024.