Bank of Canada Pauses, Leaves Rates Unchanged

After eight straight hikes, the Bank left the overnight rate at 4.5% and is continuing its policy of quantitative tightening.

Andrew Willis 8 March, 2023 | 9:38AM
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Bank of Canada building

Today, the Bank of Canada announced a hold on hikes to its key overnight rate, maintaining the rate at 4.5%. The widely expected hold on interest rates comes after eight consecutive hikes from the Bank amidst inflation brought on by persisting global political, economic, and pandemic-related factors. The Bank said it will also continue its policy of quantitative tightening.

“Global growth continues to slow, and inflation, while still too high, is coming down due primarily to lower energy prices,” the Bank said in today’s release, “In Canada, economic growth came in flat in the fourth quarter of 2022, lower than the Bank projected. “With consumption, government spending and net exports all increasing, the weaker-than-expected GDP was largely because of a sizeable slowdown in inventory investment,” the release notes, “Restrictive monetary policy continues to weigh on household spending, and business investment has weakened alongside slowing domestic and foreign demand.”

The Bank of Canada Announcement Still Seems Hawkish

In January, the Bank said, “The Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases.” This time, this was changed to say, “The Governing Council will continue to assess economic developments and the impact of past interest rate increases and is prepared to increase the policy rate further if needed to return inflation to the 2% target.”

The policy statement struck a somewhat stern tone, Capital Economics said in a note, however noting that “Despite the renewed hawkishness of central bankers elsewhere, we continue to judge that the Bank’s next move will be an interest rate cut. Dropping the explicit hint that it intends to keep policy unchanged could be a sign that the Bank has lost confidence that its 425 bp of rate hikes over the past year will be enough to get inflation back to target on a sustained basis. Nonetheless, as the popularity of variable rate mortgages means higher interest rates are feeding through to the real economy faster than elsewhere, and the January CPI data were also encouraging, it still seems unlikely that the Bank will be forced to resume raising rates.”    

Canada Slowing While Global Price Pressures Persist

In the United States and Europe, near-term outlooks for growth and inflation are both somewhat higher than expected in January, the Bank noted, “In particular, labour markets remain tight, and elevated core inflation is persisting. Growth in China is rebounding in the first quarter. Commodity prices have evolved roughly in line with the Bank’s expectations, but the strength of China’s recovery and the impact of Russia’s war in Ukraine remain key sources of upside risk. Financial conditions have tightened since January, and the US dollar has strengthened.”

The latest decision from the Bank of Canada comes a day after the U.S. Federal Reserve’s Jerome Powell warned of further rate hikes in the U.S. amidst continued strong economic growth. With inflation already easing substantially without a recession, Morningstar senior economist Preston Caldwell says the economy is capable of a soft landing, but achieving it is contingent on avoiding monetary policy error. “Near-term growth in economic activity is proving more resilient to monetary policy tightening than we had anticipated,” he says,  which is maintaining upward pressure on interest policy. “Still, we think the binary question of whether a recession will or won’t occur misses the point. That said, “Any recession is likely to be short-lived, and we expect GDP growth to rebound strongly in 2024,” he adds.

Not Off the Hook on Potential Rate Hikes

In Canada, pressures remain largely due to the tight labour market, according to the Bank’s release today: “Employment growth has been surprisingly strong, the unemployment rate remains near historic lows, and job vacancies are elevated. Wages continue to grow at 4% to 5%, while productivity has declined in recent quarters.” Meanwhile, there are signs restrictive monetary policy is beginning to take effect.

A combination of easing supply constraints along with monetary policy is winning the battle against inflation, says Caldwell, “This puts us at a more optimistic view than consensus, as we think most of the sources of inflation will unwind and aggressive capacity expansion will continue. We think that many industries that experienced a large spike in prices since the start of the pandemic will experience deflation over the next several years. This includes energy, autos, and other durable goods. Aggressive capacity expansion across many areas could turn widespread shortages into gluts within a few years.”

Don’t Think Rate Cuts Aren’t in the Cards

The U.S. may not be far from Canada and could go further with interest rate cuts later this year, according to Caldwell, as he sees policymakers “cutting interest rates aggressively starting around the end of 2023” as inflation normalizes and the need to shore up GDP growth becomes paramount.

What Should Canadian Investors Do?

"Though the Bank of Canada has kept rates steady in the latest announcement, Canadians who are in process of taking on debt (particularly via lines of credit) should remain cautious - keeping in mind that further rise in rates will increase interest payments,” says Morningstar Canada’s Director of Investment Research, Ian Tam, “Given the fact that we are coming off an era of historically low interest rates, the impact of a rate rise might feel abnormally large and may affect Canadians' ability to service (aka pay down) said debt." 

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About Author

Andrew Willis

Andrew Willis  is Senior Editor at Morningstar Canada. He previously produced content for Fidelity Investments and finance industry events for Euromoney Institutional Investor and has written in the past for Thomson Reuters and CNN. Follow him on Twitter @Andrew_M_Willis.

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