MNI BOC WATCH: 2nd Hawkish Hold On Sticky Core, Emerging Slack

The Bank of Canada left its key lending rate at the highest since 2001 at 5% for a second meeting on Wednesday citing signs that ten prior moves are opening up slack in the economy while officials remain prepared to tighten again if core inflation remains sticky.

"With clearer signs that monetary policy is moderating spending and relieving price pressures, Governing Council decided to hold," officials led by Governor Tiff Macklem said in a statement. "Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed."

The Bank's outlook pointed to stagnating conditions by cutting the 2024 growth forecast to 0.9% from 1.2% while boosting the inflation forecast half a point to 3%, and officials remain more concerned about upside inflation risks and want to see further moderation in stubborn core prices. Officials left out explicit guidance about a firm pause in rates or a shift to a high-for-long policy as other central banks signal an end of tightening and hope for a rare soft landing rather than a recession.

Inflation will return to the Bank's 2% target sometime in 2025 and officials said that will come at "about the same time" as the July projection for the middle of that year. That leaves open a return to price stability sooner or later than the earlier outlook, though the Bank said near-term inflation is boosted by crude oil and core prices. 

Canada will build up more economic slack through most of next year as higher rates further weigh on consumer and business spending, the Bank said. The global economy is also slowing and higher bond yields are weighing on demand, the Bank said, a slight shift from Macklem's recent comment higher yields are no substitute for any needed policy action.

The statement also dropped September's explicit reference to the potential for inflation to become entrenched, though it noted similar risk factors around weak productivity, elevated wage gains, increased corporate pricing power and price expectations. Inflation will remain around 3.5% until mid-2024 and slow to 2.5% in the second half of next year, the Bank's staff projection showed.

The Bank's decision to hold was expected by 19 of 20 economists surveyed by MNI, as was the idea of a statement with hawkish notes and mentioning a weaker economy. More evidence of a slowdown has emerged in recent weeks with inflation slowing to 3.8%, GDP shrinking in the second quarter and unemployment rising about half a percentage point from a record low. More than half of households now see a recession coming according to the latest quarterly BOC survey, though the Bank's new forecast showed annualized growth of 0.8% in the third and fourth quarters.

Officials also left out any reference to potential over-tightening amid public opinion polls showing anger with high interest rates and looming blame from political leaders for any recession. Raising rates further could also rattle fault lines in one of the world's most stretched housing markets. Some investors bet the BOC may start cutting rates as soon as the second quarter of next year, though Macklem has said several times it's far too soon to think about that.

Cutting rates early next year would be a rare instance of loosening with inflation sticking above target. Inflation has already exceeded 2% since March 2021 and while it dropped from a peak of 8.1% in June of last year to 3.8% core inflation remains nearly double the Bank's objective. Wages are climbing 5% from a year earlier and worker demands were underlined by a recent offer to Ford's autoworkers for a 15% raise over three years and revived talk of a contract with 1970s-style cost of living allowances.

"Governing Council wants to see downward momentum in core inflation, and continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability ," officials said.