Bank of Canada Holds Rates at 5.00% as expected, Warns CPI Higher with Gasoline Prices

Bank of Canada held its overnight rate to 5.00% in September 2023 as expected by markets, following up the 25bps rate hikes from the two previous meeting which extended its tightening cycle after the brief pause in March and April. The market was pricing in a 14% chance of a rate cut ahead of the decision. The BoC has been clear that its policy relied upon developments conforming to its expectations. That clearly has not been the case with recent data and bond action. The BOC stated that with the recent increase in gasoline prices, CPI inflation is expected to be higher in the near term before easing again

Bank of Canada Building

BoC Highlights

  • The overnight rate was raised to 5.00% Prior overnight rate was 4.75%
Canada Interest Rate
 Bank of Canada overnight rate

There is no press conference after this announcement, but BOC Governor Tiff Macklem will deliver a speech tomorrow.

  • Rates kept unchanged at 5.00%
  • The Canadian economy has entered a period of weaker growth
  • The tightness in the labor market has continued to ease gradually.
  • Recent CPI data indicate that inflationary pressures remain broad-based
  • With the recent increase in gasoline prices, CPI inflation is expected to be higher in the near term before easing again
  • With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5%
  • Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed.
  • Growth prospects in China have diminished
  • In the United States, growth was stronger than expected

Bank of Canada economic forecasts from Monetary Policy Report

Inflation

  • 2023 CPI: Projected at 3.7%, matching consensus expectation (BoC’s previous forecast was 3.5%).
  • 2024 CPI: Projected at 2.5%, above consensus expectation of 2.3% (BoC’s previous forecast was 2.3%).
  • 2025 CPI: Projected at 2.1%, slightly above consensus expectation of 2.0% (BoC’s previous forecast was 2.1%).

GDP

  • 2023 GDP Growth: Projected at 1.8%, above consensus expectation of 1.3% (BoC’s previous forecast was 1.4%).
  • 2024 GDP Growth: Projected at 1.2%, above consensus expectation of 1.0% (BoC’s previous forecast was 1.3%).
  • 2025 GDP Growth: Projected at 2.4%, significantly above consensus expectation of 1.8% (BoC’s previous forecast was 2.5%).

Neutral Rate/Output Gap

  • The BoC maintains that the midpoint of the neutral range is within 2-3%, unchanged from previous estimates.
  • The BoC estimates that the output gap is between 0% and 1% in Q2. Previously, the BoC estimated that the output gap was between 0.25-1.25%.

Market Reaction

Sticky Inflation

Strong H1 growth amplified the next leg toward the 2% inflation target being harder to achieve than the first moves.

  • Core inflation as the operational guide to achieving 2% headline inflation is on a month-over-month annualized and seasonally adjusted basis. All of the main measures are running at 4%+ as they jumped higher in April which is not something the BoC could afford to ignore.
  • The only period of marked improvement was over 2022H1 and since then these measures have been moving sideways at remarkably sticky rates notwithstanding the fact it has already been ~20 months since bond market tightening began in earnest and in anticipation of policy rate hikes.

Bank of Canada Full Rate Statement for September 2023

The Bank of Canada today held its target for the overnight rate at 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. The Bank is also continuing its policy of quantitative tightening.

Inflation in advanced economies has continued to come down, but with measures of core inflation still elevated, major central banks remain focused on restoring price stability. Global growth slowed in the second quarter of 2023, largely reflecting a significant deceleration in China. With ongoing weakness in the property sector undermining confidence, growth prospects in China have diminished. In the United States, growth was stronger than expected, led by robust consumer spending. In Europe, strength in the service sector supported growth, offsetting an ongoing contraction in manufacturing. Global bond yields have risen, reflecting higher real interest rates, and international oil prices are higher than was assumed in the July Monetary Policy Report (MPR).

The Canadian economy has entered a period of weaker growth, which is needed to relieve price pressures. Economic growth slowed sharply in the second quarter of 2023, with output contracting by 0.2% at an annualized rate. This reflected a marked weakening in consumption growth and a decline in housing activity, as well as the impact of wildfires in many regions of the country. Household credit growth slowed as the impact of higher rates restrained spending among a wider range of borrowers. Final domestic demand grew by 1% in the second quarter, supported by government spending and a boost to business investment. The tightness in the labour market has continued to ease gradually. However, wage growth has remained around 4% to 5%.

Recent CPI data indicate that inflationary pressures remain broad-based. After easing to 2.8% in June, CPI inflation moved up to 3.3% in July, averaging close to 3% in line with the Bank’s projection. With the recent increase in gasoline prices, CPI inflation is expected to be higher in the near term before easing again. Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation. The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability.

With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5% and continue to normalize the Bank’s balance sheet. However, Governing Council remains concerned about the persistence of underlying inflationary pressures and is prepared to increase the policy interest rate further if needed. Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the 2% inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Source: Bank of Canada Monetary Policy Report

From the TradersCommunity News Desk