Bank of Canada Raises Rates Amid Inflation Concerns and Economic Strength, but Challenges Loom Ahead

The Bank of Canada today announced that their discount rate increased by 25 basis points, bringing the overnight rate to 4.75% and the bank rate to 5%. In a statement by the Bank of Canada, the commitment to restoring price stability remains at the forefront. Below are some of the highlights from the announcement.

  • Canada’s economy was more robust than anticipated for the first quarter, with GDP growth at 3.1%. Consumption growth remains strong, demand for services continues to increase, the housing market strengthened and the labor market remained tight. Generally, excess demand in the economy is more tenacious than expected.
  • Consumer Price Index (CPI) inflation increased in April to 4.4% after declining for the previous 10 months. Goods prices have increased, and services inflation remains elevated. The core inflation rate has been running between 3.5% and 4% over the last several months – substantially higher than the 2% target. The Bank expects inflation to fall to 3% in the summer, driven by lower energy prices. Concerns persist that inflation could remain persistently above the 2% long-run target.
  • Globally, inflation is declining with falling energy prices, but the pace slowed over the last several months. Persistent inflation is significantly higher than the long-run target of 2%. Labor conditions remain tight, and while the goods inflation rate has declined, service inflation is elevated. Consumer spending, particularly in the U.S., remains resilient. In Europe, economic growth has stalled, but core inflation continues. China’s economy is expected to cool after a robust first quarter. Generally, central banks suggest there remains work to be done to restore pricing stability.
  • Based on the build-up of evidence, the Governing Council decided an increase in rates was appropriate to tighten monetary conditions and bring supply and demand back into balance, thereby reducing inflationary pressures.

As noted, the Bank of Canada expects inflation to fall to 3% during the summer, as gas prices decline. At the OPEC meeting this past weekend, Saudi Arabia announced further oil production cuts of one million barrels per day in July. It is common knowledge that the Saudis need $80 oil to meet their budgetary requirements and are determined to push for higher oil prices. If gas prices remain elevated, the Bank’s expectation of 3% inflation on lower gas prices this summer is optimistic.

Another consideration pushing inflation higher for the average consumer is the impact of today’s rate increase on lending rates. As the banks adjust their prime rates, lending rates are expected to rise, impacting consumer loans and mortgage renewals. Inflation will likely remain more persistent than the Bank expects, and while we may not see further tightening, 3% inflation is highly unlikely in the coming months.

Source: Bank of Canada

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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.

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