MNI STATE OF PLAY:Canada Hikes Rate, Continues QE Reinvestment

The Bank of Canada raised its key lending rate for the first time in more than three years Wednesday and said it will remain on a tightening path to curb the hottest price gains since adopting inflation targets three decades ago, while unexpectedly continuing reinvestment of bond purchases with no clear date for slimming down the balance sheet.

The rate climbed to 0.5% from a record low 0.25% and the Ottawa-based bank said further hikes and any shift to quantitative tightening depend on conditions in the economy and efforts to return inflation to its 2% target. All 20 economists surveyed by MNI predicted a 25bp hike and many saw the Bank signaling it would end the reinvestment phase of QE either this week or by April.

"Governing Council expects interest rates will need to rise further," according to a statement from the rate-setting panel. When the time is right, "quantitative tightening (QT) would complement increases in the policy interest rate."

"Inflation is now expected to be higher in the near term than projected in January," policymakers said. "Persistently elevated inflation is increasing the risk that longer-run inflation expectations could drift upwards. The Bank will use its monetary policy tools to return inflation to the 2% target and keep inflation expectations well-anchored." The Bank in January predicted inflation holding around 5% in the first half of the year and moving towards 3% by yearend, the top of its 1%-3% target band.

Governor Tiff Macklem said in January a shift was needed to a "path" of increases and balance sheet tightening would come at or after the first hike, though the word path didn't appear in today's statement. Neither did the words nimble or forceful, phrases from a recent deputy Governor's speech that triggered some market bets on a 50bp hike before the conflict in Ukraine began.

"The unprovoked invasion of Ukraine by Russia is a major new source of uncertainty. Prices for oil and other commodities have risen sharply. This will add to inflation around the world, and negative impacts on confidence and new supply disruptions could weigh on global growth," the Bank said Wednesday.

Canada’s last rate hike was October 2018 when the benchmark reached 1.75%, and the median estimate of economists before the decision was four hikes this year. Sources have told MNI the path can't be aggressive in returning rates towards neutral because indebted consumers are more vulnerable than in past cycles. Major tightening would also conflict with a government pressing ahead with fiscal stimulus even in an economy that's recovered jobs and output lost in the pandemic.

First-quarter growth looks better than projected and other data confirms Canada's economy has used up slack even through the omicron wave, the Bank said.