MNI BOC WATCH: 25BP Hike To 5%, Warning On Inflation Sticking

The Bank of Canada raised its key interest rate a quarter point to 5% Wednesday and warned inflation could get stuck above target with stronger-than-expected growth delaying the restoration of price stability another six months to mid-2025. 

The statement lacked direct forward guidance, similar to the decision to resume hiking last month. However the decision again held references to upside inflation risks and concern about expectations with prices above the 2% target for so long. Consumer price gains will "hover around 3% for the next year" and there is an "accumulation of evidence that excess demand and elevated core inflation are both proving more persistent," officials led by Governor Tiff Macklem said in a one-page statement.

"Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability," the statement read. "The Bank remains resolute in its commitment to restoring price stability for Canadians." Twenty economists surveyed by MNI predicted a quarter-point increase and two predicted a hold, though today's statement may test the consensus view the Bank would be done with hikes after today.

The 10th rate hike of this cycle follows a pause early this year as policymakers thought they had inflation under control, and the policy rate is now the highest since 2001 when it reached 5.75%. The economy’s strength continues through the longest tightening cycle since fixed meeting dates began in 2000 including the shock 100bp hike last July.

The Bank of Canada on Wednesday also raised its 2023 GDP growth forecast to 1.8% from 1.4%, backing away from an earlier view a recession was possible later this year. The quarterly Monetary Policy Report also boosted inflation forecasts to 3.7% from 3.5% for this year and to 2.5% from 2.3% in 2024. 

The Fed and ECB are also signaling tighter policy with inflation taking longer than thought to come down. Today's BOC statement didn't mention a potential higher-for-longer rate strategy, something Governor Macklem may touch on at a press conference later today as he did at his April session. 

There are cracks in the outlook including slower inflation and wage growth, some weak monthly GDP reports and a climb in unemployment from record lows. Canada's tightening comes with the risk of slamming the brakes on the economy and straining one of the world’s most stretched housing markets. Some commercial bank economists still say Canada is heading for a mild recession.

The Bank on Wednesday emphasized upside risks and surprising gains in consumption amid higher rates. "With the large price increases of last year out of the annual data, there will be less near-term downward momentum in CPI inflation," officials said. They also noted wage growth of 4%-5% and said its business conditions survey indicates firms are still raising prices more often than usual.

Inflation has slowed from a peak of 8.1% last June to 3.4% in May, though core rates are closer to 4%. Inflation has exceeded target since March 2021, increasing the danger of sticky price gains. Bank surveys and private polls suggest consumers and firms doubt CPI will return to target in the next two years. The Bank often seeks to bring inflation back to target within that time-frame.

Judging the tightness of Canada’s economy is complicated by the biggest immigration wave in decades boosting labor supply and creating more demand, especially in a stretched housing market. Bank officials said Wednesday immigration is adding both to supply and demand.

"While the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent retail trade and other data suggest more persistent excess demand in the economy," officials said. "We will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target," they said, echoing the last decision.