The Bank of Canada holds its key interest rate at 4.5%, flags difficult inflation fight

Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ontario, Canada October 26, 2022. REUTERS/Patrick Doyle

The Bank of Canada is holding its key interest rate steady at 4.5 per cent, it announced on Wednesday. (REUTERS/Patrick Doyle)

The Bank of Canada held its key interest rate steady at 4.5 per cent on Wednesday, a widely anticipated move, but one that came with an acknowledgment that getting inflation back to 2 per cent “could prove to be more difficult” for the central bank.

Economists had widely predicted that the central bank would continue to pause its rate hikes, even as some economic indicators show signs of continued overheating. Unemployment in Canada continues to hover near record lows, wage growth remains elevated relative to productivity growth, and GDP grew more than economists expected in January.

Still, the central bank said in a statement released alongside its rate decision that “recent data is reinforcing the Governing Council’s confidence that inflation will continue to decline in the next few months.”

“However, getting inflation the rest of the way back to 2 per cent could prove to be more difficult because inflation expectations are coming down slowly, service price inflation and wage growth remain elevated, and corporate pricing behavior has yet to normalize,” the Bank said in a prepared statement, adding that the Governing Council will be “particularly focused on these indicators.”

“The Governing Council continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the 2 per cent target.”

The central bank expects that consumption will moderate this year as more households renew their mortgages at higher interest rates and the impact of its rate hikes works its way through the economy. The Bank reiterated that it expects the Consumer Price Index (CPI) to come down to around 3 per cent by mid-2023, with a return to the 2 per cent target happening by the end of 2024.

The Bank of Canada did upgrade its forecast for economic growth this year, now predicting GDP will expand by 1.4 per cent in 2023, up from its previous estimate of 1 per cent. The Bank expects economic growth to shrink to 1.3 per cent in 2024 (down from its earlier estimate of 1.8 per cent) before reaching 2.5 per cent in 2025.

“Inflation expectations have to come down further, services price inflation and wage growth need to moderate, and corporate pricing behavior has to normalize,” Bank of Canada governor Tiff Macklem said at a press conference on Wednesday, adding that corporate pricing “is normalizing but it’s not normal yet.”

“Those will be the key things we’ll be using to assess whether we think interest rates are high enough to get inflation back to target.”

Rate cut ‘doesn’t look like the most likely scenario’

Last month, the Bank of Canada became the first major central bank to pause interest rate hikes following eight consecutive increases made in an effort to tame soaring inflation.

Inflation has fallen from its peak reached last June, easing to an annual rate of 5.2 per cent in February, the largest deceleration since April 2020. While inflation is still well above the Bank’s target of 2 per cent, economists had expected the central bank to remain on the sidelines while it assesses the impact of its rate hikes, or potentially cut rates later this year amid an economic slowdown.

However, regarding the cuts in 2023 Macklem said, “that doesn’t look today like the most likely scenario to us.”

“The Bank’s expectation that the economy will be in excess supply by the second half of the year opens the door a crack to potential easing later this year if inflation continues to slow down, but there’s still a lot of wood to chop on that front,” BMO chief economist Douglas Porter wrote in a note on Wednesday.

“We continue to expect the Bank to remain on hold until the end of 2023 before rate cuts begin in earnest in 2024.”

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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