BoC to keep rate hikes on pause

Canada’s economy is showing unexpected strength, creating a challenge for the country’s central bank as it prepares for its policy rate decision. The Bank of Canada was expected to hold the rate steady at 4.5% for a second straight decision, but officials have expressed confidence that higher borrowing costs are working to slow demand. However, economic data has been surprising on the upside, with a hot job market, strong wage pressures, and home prices finding a bottom after a year-long slump.

In January, when the bank first declared its intention to pause rate hikes, policymakers forecast that the economy would grow at just a 0.5% annualized pace in the first quarter. However, early indicators show growth coming in around 2.8%, defying predictions of a stall and potential recession. The resilience of the economy has thrown into doubt the view that Canada is more sensitive to higher rates than its peers due to its highly indebted households and richly-valued housing market.

Bank of Canada Governor Tiff Macklem is in a tough spot, and must navigate global banking stress while acknowledging sticky price pressures and a hotter-than-expected domestic economy, according to Dominique Lapointe, director of macro strategy at Manulife Investment Management. While the bank is expected to hold again, recent data will keep them hawkish, and some analysts, such as Citigroup Inc.’s Veronica Clark, are not ruling out a surprise increase in Wednesday’s decision, due at 10 a.m. in Ottawa.

However, Macklem wants to hold the policy rate where it is, at least for now. Inflation, while still far above the bank’s 2% target, is cooling and appears to be on a path to be closer to 3% by midyear, in line with forecasts. The release of the new monetary policy report this week will factor in expanded fiscal support from Prime Minister Justin Trudeau’s government and will provide an opportunity for the bank to address the impact of weaknesses in the global banking system.

As the first among its peers to stop raising rates, the Bank of Canada can make good on its pledge to hold borrowing costs steady while it assesses how the economy is evolving. Macklem can point to international concerns as a reason to stay on the sidelines, even though the domestic economy looks stronger than expected. Wage growth is running at a 5% yearly pace, and with some of Canada’s largest unions poised for strike action, there’s upside risk to sustained pressure on incomes. Canada’s population growth, one of the highest in the OECD, pushes up economic growth and price pressures in the short-run, including housing costs, but adds new workers who can help alleviate supply constraints in the long run.