Bank of Canada raised overnights rate by a higher-than-expected full percentage point from 1.5% to 2.5%, the market was anticipating 75 basis points. It was the fourth consecutive rate hike pushing borrowing costs to the highest level since the pandemic started. The BoC said interest rates will need to rise further and the Governing Council is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target. The risk of elevated inflation becoming entrenched has risen.
- The Bank of Canada today increased its target for the overnight rate to 2½%, with the Bank Rate at 2¾% and the deposit rate at 2½%.
“With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates,” officials said in the policy statement.
Market Reaction
- Canadian dollar soared on the move, rising more than 0.5% to C$1.2952 per US dollar at 12.14pm in Toronto trading.
- Yields on two-year sovereign bonds jumped about 10 basis points to 3.31%
- Overnight swaps suggesting BoC will hike the benchmark to 3.75% by the end of this year, up from 3.5% before the decision.
BoC Highlights
- The overnight rate is now 2.50% Prior overnight rate was 1.50%
- Ukraine war is dampening the outlook, particularly in Europe
- Previous statement said “Governing Council is prepared to act more forcefully” now says “Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank’s ongoing assessment of the economy and inflation”
- Says “the Governing Council decided to front-load the path to higher interest rates”
- The bank added analysis of a new risk scenario, in which a “self-reinforcing wage hike and price spiral” could ensue, saying that situation becomes more likely the longer inflation remains “well above” their 2 per cent target.
- The bank said real-estate activity has already weakened substantially from what it described as an “unsustainable pace” during the pandemic. It expects both housing transactions and prices to decline into 2023 as rates rise.
- Labour markets are tight with a record low unemployment rate
Inflation
- Bank of Canada raised their near-term forecasts for inflation, seeing price pressures running at around 8 per cent in the middle quarters of this year.
- Inflation in Canada is higher and more persistent than the Bank expected
- Inflation likely move even higher in the near term before beginning to ease
- The risk of elevated inflation becoming entrenched has risen
- More than half of the components that make up the CPI are now rising by more than 5%
- Surveys indicate more consumers and businesses are expecting inflation to be higher for longer
- Inflation will drop to 7.5 per cent by the end of this year, at 3% by the end of next year and won’t return to the 2 per cent target until the end of 2024.
- Global energy prices are projected to decline
- Bank acknowledged mistakes in forecasting inflation over the last year. It primarily blamed the errors on global factors, but also cited domestic housing costs.
Growth
- Slashed outlook for the Canadian economy with gross domestic product expanding 3.5 per cent this year and 1.8 per cent in 2023, down from 4.2 per cent and 3.2 per cent respectively, as global growth moderates and tighter monetary policy impacts activity.
- BOC expects Canada’s economy to grow by 3½% in 2022, 1¾% in 2023, and 2½% in 2024.
- BOC estimates that GDP grew by about 4% in the second quarter and sees about 2% in Q3
Bank of Canada Full Rate Statement for July 2022
The Bank of Canada today increased its target for the overnight rate to 2½%, with the Bank Rate at 2¾% and the deposit rate at 2½%. The Bank is also continuing its policy of quantitative tightening (QT).
Inflation in Canada is higher and more persistent than the Bank expected in its April Monetary Policy Report (MPR), and will likely remain around 8% in the next few months. While global factors such as the war in Ukraine and ongoing supply disruptions have been the biggest drivers, domestic price pressures from excess demand are becoming more prominent. More than half of the components that make up the CPI are now rising by more than 5%. With this broadening of price pressures, the Bank’s core measures of inflation have moved up to between 3.9% and 5.4%. Also, surveys indicate more consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price- and wage-setting. If that occurs, the economic cost of restoring price stability will be higher.
Global inflation is higher, reflecting the impact of the Russian invasion of Ukraine, ongoing supply constraints, and strong demand. Many central banks are tightening monetary policy to combat inflation, and the resulting tighter financial conditions are moderating economic growth. In the United States, high inflation and rising interest rates are contributing to a slowdown in domestic demand. China’s economy is being held back by waves of restrictive measures to contain COVID-19 outbreaks. Oil prices remain high and volatile. The Bank now expects global economic growth to slow to about 3½% this year and 2% in 2023 before strengthening to 3% in 2024.
Further excess demand has built up in the Canadian economy. Labour markets are tight with a record low unemployment rate, widespread labour shortages, and increasing wage pressures. With strong demand, businesses are passing on higher input and labour costs by raising prices. Consumption is robust, led by a rebound in spending on hard-to-distance services. Business investment is solid and exports are being boosted by elevated commodity prices. The Bank estimates that GDP grew by about 4% in the second quarter. Growth is expected to slow to about 2% in the third quarter as consumption growth moderates and housing market activity pulls back following unsustainable strength during the pandemic.
The Bank expects Canada’s economy to grow by 3½% in 2022, 1¾% in 2023, and 2½% in 2024. Economic activity will slow as global growth moderates and tighter monetary policy works its way through the economy. This, combined with the resolution of supply disruptions, will bring demand and supply back into balance and alleviate inflationary pressures. Global energy prices are also projected to decline. The July outlook has inflation starting to come back down later this year, easing to about 3% by the end of next year and returning to the 2% target by the end of 2024.
With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today. The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank’s ongoing assessment of the economy and inflation. Quantitative tightening continues and is complementing increases in the policy interest rate. The Governing Council is resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target.
Information note
The next scheduled date for announcing the overnight rate target is September 7, 2022. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the MPR on October 26, 2022.
Source: Bank of Canada
From the TradersCommunity News Desk