Bank of Canada’s Proactive Monetary Policy Adjustments Signal Economic Resilience and Inflationary Pressures

In a momentous and resolute decision, the Bank of Canada has taken a significant step by raising both its key overnight interest rate and Bank Rate. With a 25-basis point increase, the key overnight interest rate now stands at 5%, reaching a level unseen since 2001. In parallel, the Bank Rate has also been raised to 5.25%. These notable adjustments reflect the Bank’s proactive approach to shaping monetary policy. Moreover, amidst these changes, the Bank remains steadfast in its commitment to the continued implementation of its quantitative tightening policy.

Governor of the Bank of Canada, Tiff Macklem, attributes the delayed impact of higher interest rates to lingering pandemic savings. Despite lower inflation, including lower energy prices, more than half of the consumer price index basket continues to experience rising costs, with certain items undergoing significant increases. Nonetheless, Canada’s economy has exhibited unexpected resilience, characterized by strong demand momentum and consumption growth at 5.8%.

Although interest rate hikes are expected to slow consumer spending, recent data suggest that excess demand persists within the economy. The housing market has experienced a resurgence, leading to price pressures with demand outpacing new construction and real estate listings. While increased worker availability is observed in the labor market, conditions remain tight, as wage growth averages 4-5%. The influx of immigrants has been a contributing factor to population growth, which, in turn, has mitigated labor shortages, bolstered consumer spending and spurred demand for housing.

As the impact of higher interest rates continues to permeate the economy, the Bank predicts a slowdown in economic growth, averaging approximately 1% in the latter half of this year and the first half of the next. This translates to a real GDP growth rate of 1.8% in 2023 and 1.2% in 2024.

Despite inflation in Canada declining to 3.4% in May from its peak of 8.1% the previous summer, the downward momentum has been primarily driven by lower energy prices rather than underlying inflation. Core inflation rates have remained around 3.5-4% since September, indicating a more persistent underlying price pressure than originally expected. The July Monetary Policy Report forecasts that CPI inflation will hover around 3% in the coming year, gradually declining to 2% by mid-2025. This represents a slower return to the targeted rate compared to earlier projections. The Governing Council of the Bank continues to express concerns that progress toward the 2% target may stagnate, thereby jeopardizing price stability.

On a global scale, the inflation outlook demonstrates signs of moderation due to lower energy prices and a decline in goods price inflation. However, persistent inflationary pressures in services persist due to robust demand and tight labor markets. The United States has witnessed stronger-than-anticipated economic growth, whereas China’s economy has experienced a softening trend along with weakness in the property sector. The euro area is grappling with effectively stagnant growth, characterized by service sector expansion juxtaposed with manufacturing contraction. As a result, major central banks in North America and Europe have indicated potential interest rate increases to address inflation amidst tightening global financial conditions.

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

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