The Bank of Canada raised its key rate to 3.25 per cent on Wednesday, the fifth increase in six months. More hikes are on the way to tame inflation that is too widespread in the economy, according to the central bank.
Economists are talking about the decision.
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The BoC took little solace in the gasoline price-driven decline in headline inflation in July, even though the statement leaned slightly hawkish. We think core measures will move higher in August. The BoC will want to see core measures move lower before it stops rate hikes. The inflation expectations component of the business and consumer surveys will be watched for improvement by the governing council. The BoC hiked the repo rate by 100 bp in July, and today's statement noted that short-term inflation expectations are high. The BoC emphasized strong domestic demand and a housing market that is pulling back as expected after Q2 GDP came in softer than expected. The bank still expects growth to moderate in the second half of the year, despite the economy carrying little steam into Q3. The BoC wants to pull that off without tipping the economy into recession, but it still wants to get inflation under control. We think there will be a mild recession in the years to come.
We will be bumping down our GDP projections for Canada in an updated forecast to be released next week because the BoC appears ready to sacrifice more growth than we expected. If the Bank had believed that 3.5 per cent was the ceiling, they could have decided to go for a higher rate. It would be a half point above what we had built into our previous GDP call, which is material to the outlook.
The statement was focused on inflation. The Bank has not let up despite the fact that the inflation in July was less than expected. The statement says that the data indicates a further broadening of price pressures, particularly in services. The BoC believes that service inflation can have an impact through rate hikes. Despite the below- expected Q2 GDP report, the economy continues to operate in excess demand. The Bank expects growth to slow in the second half of the year. policymakers want to see a few quarters of below- potential growth and some easing of labour market conditions before they are more comfortable with the inflation outlook The governing council decided that the policy interest rate would need to rise further. They will assess how much higher interest rates need to go. The only question is how big the next hike will be. The door is open for the data to guide the decision, but the tone of the statement is very concerned about inflation. We will let the data flow over the next seven weeks sway that call either higher or lower depending on the strength of inflation and growth.
The Bank of Canada continues to raise rates. The policy rate has been moved into economically restrictive territory by this hike. In our report this morning, we pointed out that the Bank has focused on the near-term data instead of the economy. The BoC is expected to raise the policy rate to 4% by the end of the year. As the BoC tries to achieve price stability, there will be more growth sacrifice.
With the economy slowing and inflation easing more than the Bank expected, we still see scope for it to follow today's 75 bp hike with a smaller 25 bp move in October. The 75 bp policy rate hike was in line with expectations and means the policy rate is now above the Bank's 2 per cent to 3 per cent neutral range estimate. The Bank highlighted in the policy statement that it still judges that the policy interest rate will need to rise further, but gave very little information about the magnitude of any further moves. The Bank highlighted the strength of domestic demand while acknowledging that second-quarter GDP growth was somewhat weaker than it had projected. The Bank's statement focused on the rise in core inflation, even though inflation was less than expected. The trade data this morning shows a drop in import volumes in July, as well as a sharp fall in retail sales in that month. Most of the recent upward pressure on services prices is expected to be reversed after the peak summer travel season. If the Bank's next quarterly surveys don't show a rise in long-term inflation expectations, we think this will cause the Bank to drop down to a 25 bp hike in October.
The headline decision came out as expected, even though there was a lot of outcomes going into the meeting. We think this statement is on the right side of the spectrum. The Bank made it clear that rates will need to rise further still. We will be assessing how much higher interest rates need to go, but how much further has been left open to debate? We would expect a decrease in the pace of rate increases. The debate is likely to be centered on 50 basis points for the next meeting compared to 100 basis points now. Incoming data should have a significant influence on the late October decision, but the focus will be on core/service inflation as they look through any relief brought on by falling gas prices. The Bank does not intend today's hike to be its last, so we will wait until tomorrow to make a decision. The BoC issolute in their commitment to price stability and will do what it takes to get inflation back to 2%. Policy decisions have been made because prices are not stable.
The Bank believes inflation is top of mind and it will do whatever it takes to eradicate it. Good luck finding any cracks in its resolve if you find them in the press release. The implications for the Canadian economy are beginning to show up. As monthly prints converge to more typical levels, inflation is expected to trend lower. Softening demand for goods and easing global supply chains are part of the story. Statistics Canada's flash estimate shows that real GDP growth will contract in July. Q3 real GDP growth of around 1 per cent is shy of the Bank's forecast for the second quarter in a row. As rates continue to rise, the economic impacts of the housing market correction will become more apparent. The job of the governing council is going to get harder. Monetary policy tightening is going to make the economy grow slower. We think that the Canadian economy is going to fall into a mild recession in the first half of next year due to the correction in the Canadian housing market.
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