MNI BOC WATCH: Macklem Hikes 25, Sees Pause If Growth On Track

The Bank of Canada raised its key lending rate 25bps to 4.5% Wednesday and policy makers expect this to be the peak because of confidence the economy is on track to pull back overheated demand and hasten progress slowing inflation to target.

“If economic developments evolve broadly in line with the Monetary Policy Report outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases. Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target,” policymakers led by Governor Tiff Macklem said in a statement. "There is growing evidence that restrictive monetary policy is slowing activity, especially household spending." The statement is a shift from December's more even-handed comment the Bank was weighing whether or not to hike again. 

The increase was expected by 18 of 20 economists surveyed by MNI though the statement was bolder in calling for inflation to ease "significantly" this year and the forecast paper said the economy should move from excess demand to "modest" excess supply. Officials project inflation will slow from 6.3% to about 3% around midyear and return to 2% in 2024, faster than its October view the target wouldn't be hit until the end of next year.

Also dropped from Wednesday's statement was previous language about the growing risk of inflation becoming entrenched the longer it remained above target. Last year officials expressed doubts about their inflation forecasting after abandoning a measure of core prices and missing the surge of CPI to more than 8% as Canada's economy rebounded after pandemic lockdowns. The global backdrop is clearer now with signs of resiliency in the U.S. and Europe and China easing Covid rules, the Bank said Wednesday.

The Bank's eighth straight tightening is the longest series since it moved to fixed meeting dates in 2000 and the benchmark is now the highest since 2007. The latest move helps restore Canada as having the G7’s most aggressive hiking campaign and the highest rate ahead of the Fed’s 4.25%-4.5% range. The Fed is expected to raise again after its Jan. 31-Feb. 1 meeting.  

Canada’s policy rate remains negative versus the current rate of CPI and some measures of consumer inflation expectations over the next year or two. The Bank sets rates to keep inflation in the middle of a 1%-3% band and return to target within two years, and price gains have already topped 2% since March 2021.

The Bank affirmed its view Canada's economy will stall through the first half of the year, and its forecast paper said there's less risk now of a wage-price spiral. There is evidence rate hikes are working to slow demand, such as a record 4.1% monthly drop in household appliance prices. The vulnerability of a nation with some of the world's frothiest housing markets to higher rates is another wild card for rates this year.

Other reports show a very tight economy, including third-quarter GDP growth at about a 3% annualized pace and the unemployment rate near a record low around 5%. Provincial governments are mailing out new relief checks that make the inflation fight harder. The Bank lowered its full-year inflation forecast for 2023 to 3.6% from 4.1% and its GDP forecast was little changed at 1%. 

"As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment are expected to slow. Meanwhile, weaker foreign demand will likely weigh on exports. This overall slowdown in activity will allow supply to catch up with demand," the bank said. 

Macklem holds a press conference at 11am EST, and meeting minutes will also be published for the first time following this decision, with a delay of two weeks.