The decision was driven by bank of canada’s fear that efforts to bring inflation back to its 2 percent target could be impeded by excessive consumer spending.
The Bank of Canada (BoC) made a significant move on Wednesday, increasing its key overnight interest rate by a quarter of a percentage point to reach a 22-year high of 5 percent.
This rate hike, the second in as many months, was widely anticipated by analysts and markets. In June, after a five-month pause, the Bank of canada raised its overnight rate, stating that monetary policy was not sufficiently restrictive.
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In its statement on Wednesday, the BoC removed the line indicating that rates were not restrictive enough. However, it raised its growth forecast for this year and extended its expectations for achieving the inflation target by six months to mid-2025.
Derek Holt, the Vice President of Capital Markets Economics at Scotiabank, noted that members of the Bank of Canada governing council still appear open to further tightening. He suggested that the central bank may simply be taking a break for the summer.
Following this move, Canadian money markets increased their bets for another rate increase. There is now an almost 40 percent probability of another hike at the next policy announcement scheduled for September.
The BoC explained its decision in a statement, saying, “With three-month measures of core inflation running in the 3.5 percent to 4 percent range for several months and excess demand persisting, concerns have increased that CPI [consumer price index] inflation could get stuck materially above the 2 percent target.”
Despite nine previous rate increases totaling 450 basis points since March of the previous year, the Canadian economy regained momentum in May. It is expected to have grown by around 0.4 percent on a monthly basis, bouncing back from a stall in April.
Andrew Kelvin, Chief Canada Strategist at TD Securities, stated that the BoC is likely done with rate hikes for now. However, he noted that the tone of the statement suggests a risk of another possible hike in September.
The Bank of Canada adjusted its forecast for second-quarter annualized growth, increasing it from 1 percent in April to 1.5 percent. The third quarter is also expected to see growth of 1.5 percent. Overall, the projected real gross domestic product growth for 2023 is 1.8 percent, up from the April forecast of 1.4 percent.
According to the BoC, the rebalancing of supply and demand is now expected to occur in early 2024, as highlighted in the report containing the new forecasts released on Wednesday. The central bank attributes persistent demand, higher-than-expected housing costs, and a more gradual decline in goods prices (excluding food and energy) as factors driving inflation.
The Bank of Canada stated, “Inflation is expected to return to 2 percent in the middle of 2025, although the timing is uncertain given the gradual movement of inflation toward the target.”
The last time the BoC’s overnight target rate reached 5 percent was in March and April of 2001.
Out of the 24 economists surveyed by Reuters, 20 had expected the central bank to raise rates by a quarter of a percentage point. Money markets had indicated a more than 70 percent chance of a rate hike before the announcement.