Bank of Canada Raises Rates, “Conditional Pause” Due To Strong Economy

Canadians are bracing themselves for the impact of higher interest rates. This morning, the Bank of Canada (BoC) announced another hike to the overnight rate. The central bank justified the move by citing a strong economy and excess demand. Even with the strength, they plan to hit pause “conditionally” on any higher moves to assess the impact.

Bank of Canada Hikes Rates By 25 Basis Points

The BoC raised interest rates by a standard hike, now tied with the highest level in a generation. The overnight rate climbed by 25 basis points (bps) to 4.50% on Wednesday, adding 425 basis points in less than a year. Canadians haven’t seen interest rates climb at this speed since the 90s—nearly 3 decades ago.

Interest rates are also at a level that hasn’t been seen since 2007, and then, they weren’t around for long. That era only maintained a 4.5% rate for five months before the Global Financial Crisis hit, and they tumbled. 

Canada’s Economy Is Still Very Robust

Canada’s overnight rate is likely a little high, but it’s nothing like the GFC warranting a sharp cut. In fact, the BoC attributes today’s hike to an economy outperforming their expectations. “Simply put, our overheated economy did not cool as much as we expected,” said BoC Governor Tiff Macklem at a conference following the hike. 

The central bank cited few signs of a recession in the labor market that remains tight. Governor Macklem pointed to elevated job vacancies, robust wage growth, and low unemployment. He also cited BoC survey data showing businesses are having trouble finding labor. Typically these aren’t the kind of points made when the economy requires easier policy.

Despite the strong data, the Governor’s outlook sent very mixed signals. Real gross domestic product (GDP) is forecast to show 3.5% growth in 2022. By 2023, that’s expected to fall to just 1%, with 2% following in 2024. Not particularly strong for aggregate growth when population growth might outpace it. 

Bank of Canada Is Forecasting Rapidly Falling Inflation, But They Always Do

The BoC’s expectations of a slowing economy are seen bringing down inflation rapidly. The current target for the consumer price index (CPI) annual growth is 2%, with 3% being an upper bound. By mid-year, they see just 3% growth in their forecast, and reach their target by 2024.

Keep in mind, this means inflation will have to trim by more than half in just a few months. It’s hard to expect such an ambitious goal when inflation data hasn’t moved in the direction of the Governor’s forecast… well, since he took office.

It’s worth emphasizing how inflation impacts their forecast for real GDP growth. Real GDP at 1% in 2023 means they can’t be off by more than 1%, or they effectively have no growth. Once again, fairly ambitious planning is happening here.

The Governor stressed that hitting pause is conditional on tapering excess demand. They’ll be monitoring the market for sufficient cooling, as well as executing quantitative tightening (QT) to help ensure expectations don’t soften too quickly.