The Bank of Canada raised interest rates again on Wednesday and released new projections that suggest it will take longer to get inflation back to two per cent.
The central bank hiked its key interest rate by a quarter of a percentage point, bringing it to five per cent.
Forecasters were widely anticipating the central bank to raise rates as the economy continues to run hotter than expected, despite interest rates being at the highest levels in decades.
The Bank of Canada says the rate hike was prompted by elevated demand in the economy driven by strong consumer spending, as well as signs that prices continue to rise rapidly.
"These decisions are difficult, and we did discuss the possibility ofholding rates unchanged and gathering more information to confirm the need to raise the policy rate," Bank of Canada governor Tiff Macklem said.
"On balance, our assessment was that the cost of delaying action was larger than the benefit of waiting."
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Macklem said the central bank is trying to balance the risks of over- and under-tightening.
"If new information suggests we need to do more, we are prepared to increase our policy rate further. But we don’t want to do more than we have to," he said.
"These decisions will be guided by our assessment of incoming data and the outlook for inflation. We need to see demand growth slow, wage pressures moderate and corporate pricing behaviour normalize."
The decision Wednesday follows a rate hike in June, which brought the central bank’s previous pause on interest rate increases to an end.
The Canadian economy was widely expected to stall this year, but instead, economic data has been stronger than most forecasters, including the central bank, had expected.
And although inflation has fallen considerably since last summer, prices for many goods and services continue to rise rapidly.
Canada’s inflation rate reached 3.4 per cent in May, down from 8.1 per cent last summer. Meanwhile, grocery prices rose nine per cent in May compared to a year ago.
The central bank’s updated economic projections released in its monetary policy report suggest it will take Canada longer to get back to the two per cent target.
The Bank of Canada now expects inflation to stall around three per cent for the next year, before steadily declining to two per cent by mid-2025.
“This is a slower return to target than was forecast in the January and April projections. Governing council remains concerned that progress toward the two per cent target could stall, jeopardizing the return to price stability,” the Bank of Canada said.
The central bank also expects stronger economic growth this year both globally and domestically. It revised its projection for real gross domestic product growth in Canada to 1.8 per cent for 2023, up from 1.1 per cent.
Here’s what the Bank of Canada’s decision and monetary policy report, and remarks from Macklem and senior deputy governor Carolyn Rogers as they spoke to reporters after the announcement mean:
Recession likely not in the cards
The Bank of Canada doesn’t expect a recession, despite the squeeze higher rates are putting on the economy, Macklem said.
The central bank expects economic growth to average around one per cent for the next year before picking up after that.
“We need a period of growth below trend, below potential, to let supply catch up with demand. That's what's going to relieve those price pressures,” Macklem said.
“But we do think that there's a path back to price stability, while with the economy still growing.”
Two per cent inflation is still far away
The central bank doesn’t see inflation reaching its target of two per cent until the middle of 2025.
Macklem said he expects the consumer price index, which measures inflation to grow at around three per cent for the next year before gradually declining to target.
“This is about six months later than we expected in April,” he said.
Don’t expect rate cuts any time soon
Interest rates may get even higher if the data supports it, but they’re not getting lower in the near future, Macklem said.
“It's clearly too early to be talking about interest rate cuts,” he said.
“We are certainly trying to balance the risks of over- and under-tightening and we'll be taking it one meeting at a time.”
Population growth is both hurting and helping inflation
Canada’s rapidly growing population, which recently surpassed a milestone at 40 million, is contributing to inflationary pressure with spending and housing demand, Macklem said.
That’s despite the fact that newcomers to Canada are also helping ease tightness in the labour market.
“Rapid population growth is contributing to both supply and demand in the economy,” Macklem said. “Newcomers to Canada are entering the labour force, easing labour shortages, but at the same time they add to consumer spending and the demand for housing.”
Pandemic savings are still flowing
While Macklem acknowledged that higher interest rates are likely hurting many Canadian households, he said spending is still strong, especially on services, and that’s contributing to stubborn inflation.
One potential reason for this is that the savings Canadians built up during the pandemic are helping buoy spending despite rate hikes, he said.
“Some households have cut back on spending because inflation and higher interest rates have eaten into their budgets, and some are being severely squeezed,” said Macklem.
“But for many, larger savings may be acting as a buffer and supporting consumer spending.”
The central bank is in a balancing act
The Bank of Canada is concerned that if it doesn’t act strongly enough now, Canadians will pay the price later, said Macklem.
“The downward momentum in inflation is waning, and we are concerned that if we're not careful, the progress to price stability could stall,” he said.
If the economy sees any upward surprises, inflation could even move back up, warned Macklem.
“We're trying to balance the risks of under and over tightening,” he said.
“We know that if we don't do enough now, we'll likely have to do even more later. We also know, though, that if we do more than we need now, it's going to be unnecessarily painful.”
