Bank of Canada Raises Rates After Five Month Pause by 25bps to 4.75%

Bank of Canada raised its overnight rate to 4.75% in June 2023, the market has priced in a 60% chance of a hike, the Candian dollar rallied immediately after the release. The move follows the surprise hike by the Reserve Bank of Australia yesterday. The BoC has been clear that its conditional hold since January relied upon developments conforming to its expectations. That clearly has not been the case with recent data and bond action. The 3.1% GDP surprise in Q1 exceeded the BoC’s 2.3% forecast. Prior to January there were a series of aggressive hikes. The BOC stated that underlying inflation remains stubbornly high and the Bank continues to expect CPI inflation to ease to around 3% in the summer

Bank of Canada Building

BoC Highlights

  • The overnight rate was raised to 4.75% Prior overnight rate was 4.50%
  • The Bank Rate is now at 5% and the deposit rate at 4¾%.
  • The Bank of Canada last hiked rates in January
  • Canada’s economy was stronger than expected in the first quarter of 2023
  • The labour market remains tight.
  • The Bank is implementing a policy of quantitative tightening.
  • Underlying inflation remains stubbornly high
  • Consumption growth was surprisingly strong and broad-based
  • Spending on interest-sensitive goods increased and, more recently, housing market activity has picked up
  • The Bank increased the policy interest rate to address the imbalance of supply and demand and return inflation to the target.
  • The Bank continues to expect CPI inflation to ease to around 3% in the summer
  • Concerns have increased that CPI inflation could get stuck materially above the 2% target.
  • Major central banks are signaling the need for further interest rate increases to restore price stability.
  • The Bank will continue to monitor core inflation dynamics, CPI outlook, inflation expectations, wage growth, and corporate pricing behavior.
Canada Interest Rate
 Bank of Canada overnight rate

Key passage from the statement:

The statement no longer says the BOC “remains prepared to raise the policy rate further if needed to return inflation to the 2% target”

This suggests not as hawkish and perhaps a final hike.

The Bank continues to expect CPI inflation to ease to around 3% in the summer, as lower energy prices feed through and last year’s large price gains fall out of the yearly data. However, with three-month measures of core inflation running in the 3½-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target.

Now:

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 behaviour are consistent with achieving the inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Market Reaction

  • US to the Canadian dollar USD/CAD saw the CAD strengthen. USD/CAD moved lower after the report to 1.33199 from before the announcement 1.3384.
  • The price bounced back up at 1.3349 as support held and chatter of final hike.
  • Rate divergence between US and Canada

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 June 2023

The Bank of Canada today increased its target for the overnight rate to 4¾%, with the Bank Rate at 5% and the deposit rate at 4¾%. The Bank is also continuing its policy of quantitative tightening.

Globally, consumer price inflation is coming down, largely reflecting lower energy prices compared to a year ago, but underlying inflation remains stubbornly high. While economic growth around the world is softening in the face of higher interest rates, major central banks are signalling that interest rates may have to rise further to restore price stability. In the United States, the economy is slowing, although consumer spending remains surprisingly resilient and the labour market is still tight. Economic growth has essentially stalled in Europe but upward pressure on core prices is persisting. Growth in China is expected to slow after surging in the first quarter. Financial conditions have tightened back to those seen before the bank failures in the United States and Switzerland.

Canada’s economy was stronger than expected in the first quarter of 2023, with GDP growth of 3.1%. Consumption growth was surprisingly strong and broad-based, even after accounting for the boost from population gains. Demand for services continued to rebound. In addition, spending on interest-sensitive goods increased and, more recently, housing market activity has picked up. The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour. Overall, excess demand in the economy looks to be more persistent than anticipated.

CPI inflation ticked up in April to 4.4%, the first increase in 10 months, with prices for a broad range of goods and services coming in higher than expected. Goods price inflation increased, despite lower energy costs. Services price inflation remained elevated, reflecting strong demand and a tight labour market. The Bank continues to expect CPI inflation to ease to around 3% in the summer, as lower energy prices feed through and last year’s large price gains fall out of the yearly data. However, with three-month measures of core inflation running in the 3½-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target.

Based on the accumulation of evidence, Governing Council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target. Quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the Bank’s balance sheet. 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 behaviour are consistent with achieving the inflation target. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Bank of Canada’s Quarterly Monetary Policy Report (March 2023)

  • 2023 GDP seen at 1.4% vs 1.0% prior
  • 2024 GDP seen at 1.3% vs 1.8% prior
  • 2025 GDP seen at 2.5%
  • 2023 CPI seen at 3.0% vs 3.6% prior
  • 2024 CPI seen at 2.0% vs 2.3% prior
  • Goods price inflation is easing quickly, reflecting lower energy prices, improved global supply chains and the effects of restrictive monetary policy on sectors sensitive to interest rates. Inflation is then forecast to return the rest of the way to the 2% target more gradually because services price inflation is responding more slowly to the effects of restrictive monetary policy.
  • Strong population growth is supporting aggregate consumption and employment growth. Household spending is being restrained by higher interest rates.
  • At current interest rates, the share of income spent on interest payments will continue to rise as homeowners renew their mortgages. Growth in business investment and exports is also expected to soften, reflecting increased borrowing costs and weaker foreign demand.

Information note
The next scheduled date for announcing the overnight rate target is July 12, 2023. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the Monetary Policy Report at the same time.

Source: Bank of Canada Monetary Policy Report

From the TradersCommunity News Desk