The Bank of Canada (BoC) opted to maintain its key overnight interest rate at 5% on Wednesday, demonstrating its cautious stance amidst signs of weakening economic growth. The central bank’s decision came as Canada faced an unexpected contraction in its gross domestic product, a situation that has raised concerns of a potential recession. While acknowledging this economic softening, the BoC underscored its readiness to raise borrowing costs again if inflationary pressures persist.
In its efforts to combat persistently elevated inflation, which has surpassed the bank’s 2% target for an extended 27-month period, the BoC had previously raised interest rates by a quarter point in both June and July. This tightening of monetary policy aimed to rein in rising prices in various sectors of the economy.
The second quarter of the year proved less than stellar for Canada, as its gross domestic product unexpectedly shrunk by an annualised 0.2%. This development added weight to concerns that the nation had already slipped into a recessionary phase. Nevertheless, the inflation rate surged to 3.3% in July, with core measures hovering around 3.5%.
Explaining its decision to maintain the status quo, the BoC articulated, “With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5%.”
While the central bank expressed its willingness to further raise rates in the face of persistent inflation, financial analysts tempered expectations of immediate hikes. Doug Porter, Chief Economist at BMO Capital Markets, commented, “The Bank has certainly left the door ajar to the possibility of more hikes, but unless growth rebounds in Q3 – which we doubt – the BoC is likely done with rate hikes.”
The Canadian dollar registered a 0.1% decrease, trading at 1.3655 to the US dollar, following a dip to a five-month low of 1.3676.
Moreover, the Canadian 2-year yield lagged behind its US counterpart by 6.3 basis points, creating a gap of 36.5 basis points in favour of the US note. This divergence in yields reflects the market’s adjustment to the BoC’s decision.
Expectations leading up to the BoC meeting were limited, with money markets assigning a mere 14% chance of a rate hike. In line with this sentiment, 31 out of 34 economists surveyed by Reuters between August 24 and 30 anticipated no change in the central bank’s overnight rate.
Andrew Kelvin, Chief Canada Strategist at TD Securities, noted, “We don’t expect to see a quick turnaround in economic activities, with growth expected to remain on the slow side in the third quarter. We expect they will also remain on hold in the October and December meetings.”
Bank of Canada Governor Tiff Macklem is scheduled to deliver a speech and hold a press conference to provide further insights into the central bank’s decision on Thursday.
The BoC acknowledged that recent surges in gasoline prices, exceeding the assumptions made in its previous economic forecasts from July, would lead to a short-term uptick in inflation before subsiding.
Simultaneously, the central bank highlighted that the current interest rates, which stand at a 22-year high, are having a constraining effect on spending “among a wider range of borrowers.” This dynamic has coincided with the economy entering a phase of subdued growth, a necessary development to alleviate inflationary pressures.
Last year, inflation reached a four-decade high of 8.1%, prompting the BoC to initiate a series of ten rate hikes since March 2022 in an attempt to steer inflation back towards its target range.
Amidst these economic challenges, Liberal Prime Minister Justin Trudeau has faced criticism for the inflationary environment, with his Conservative rival, Pierre Poilievre, alleging that government spending under Trudeau’s leadership has fuelled inflation and exacerbated the housing crisis.
In response to the BoC’s decision, Finance Minister Chrystia Freeland remarked, “The Bank of Canada’s decision to maintain its overnight interest rate is welcome relief for Canadians.”
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