MNI BOC WATCH: Hold at 5% And Signals Hike On Sticky Inflation

The Bank of Canada left its key lending rate at the highest since 2001 at 5% Wednesday and signaled officials remain prepared to hike again because of the risk elevated price gains become entrenched amid slow progress wrestling down inflation.

The one-page statement pointed to upside risks like elevated wages and core inflation even as growth stalls, while declining to return to past comments rates may be high enough or the risk of over-tightening. Economists surveyed by MNI expected a rate hold after two prior increases and a statement with hawkish notes. 

"Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed," the group led by Governor Tiff Macklem said in a decision that will be followed Thursday with a speech and press conference. Officials held rates because of "recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy."

Holding rates mirrors Fed discussions about nearing the end of a tightening cycle and a global economy hit by slowing growth in China at a time when Canada's economy is also fading after a period of unexpected strength. The Bank said weaker growth is "needed to relieve price pressures" and noted the Q2 GDP decline points to the drag of 10 rate hikes re-balancing overheated demand, such as slower consumer credit growth and spending.

"The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability," the Bank said, adding inflation remains broad-based, wage gains are tracking between 4% and 5% and there's little slowing of core prices. 

Price gains are also seen quickening in the near term to reflect higher gasoline prices, the Bank said. The CPI already climbed to 3.3% from 2.8% in the latest report to take it back outside the Bank's 1% to 3% target band. While inflation slowed from a peak of 8.1% it's been above the Bank's 2% target since March 2021 and in July officials pushed out their forecast of restoring the target until mid-2025. That's about the outer limit of the time over which a rate hike is seen having a drag on the economy.

The Bank is now balancing the potential for a mild recession and disorder in one of the world's most stretched housing markets against the risk that even the most aggressive hiking cycle since inflation targets were adopted decades ago won't restore price stability. New supply-chain challenges are have emerged that could add to inflation like flooding in Nova Scotia, wildfires shutting down Alberta energy production and a strike at the nation’s biggest port in Vancouver. Government program spending is also up 10% from a year ago. Bank surveys and private polls suggest consumers and firms doubt CPI will return to target in the next two years.

Judging the tightness of Canada’s economy is complicated by the biggest influx of immigrants in decades boosting labor supply and creating more demand. While the unemployment rate has climbed for months from record lows much of that is tied to record population growth.

Economists see the Bank’s key rate peaking at 5% and staying there until the middle part of next year and Macklem told reporters in July “it’s clearly too early to be talking about interest-rate cuts.”

The Bank's decision Wednesday noted other nations also face difficult trade-offs, saying "inflation in advanced economies has continued to come down, but with measures of core inflation still elevated, major central banks remain focused on restoring price stability."