Bank of Canada raises rate to 5%: what we’ve learned about inflation and the economy
OTTAWA — The Bank of Canada raised its key interest rate by 0.25 percentage point to five percent on Wednesday.
Governor Tiff Macklem says inflationary pressures are not easing as fast as the central bank wants, and more rate hikes could come if economic data supports it.
Here’s what we learned from the Bank of Canada’s decision and monetary policy report, and comments from Macklem and Senior Deputy Governor Carolyn Rogers when they spoke to reporters following the announcement.
Recession probably not in the cards
The Bank of Canada does not expect a recession, despite pressures from higher interest rates on the economy, Macklem said.
The central bank expects economic growth to average around 1 percent in the coming year, before picking up again.
“We need a period of growth below trend, below potential, for supply to catch up with demand. That’s what’s going to ease that pricing pressure,” Macklem said.
“But we think there is a way back to price stability, while the economy is still growing.”
Two percent inflation is still a long way off
The central bank does not see inflation reaching its target of two percent until mid-2025.
Macklem said he expects the consumer price index, which measures inflation, to grow about three percent over the next year before gradually falling to the target.
“This is about six months later than we expected in April,” he said.
Don’t expect interest rate cuts anytime soon
Interest rates could go even higher if the data supports it, but they won’t go lower in the foreseeable future, Macklem said.
“It is clearly too early to talk about interest rate cuts,” he said.
“We are certainly trying to balance the risks of too much and too little tightening and we will take it meeting to meeting.”
Population growth hurts and helps inflation
Canada’s fast-growing population, which recently passed a milestone of 40 million, is adding to inflationary pressures with spending and demand for housing, Macklem said.
This is despite the fact that newcomers in Canada are also helping to alleviate the tight labor market.
“Rapid population growth contributes to both supply and demand in the economy,” Macklem said. “New arrivals in Canada are entering the workforce, alleviating labor shortages, but at the same time contributing to consumer spending and demand for housing.”
Pandemic savings are still pouring in
While Macklem acknowledged that higher interest rates are likely to hurt many Canadian households, he said spending is still high, especially on services, and that this is contributing to persistent inflation.
One possible reason for this is that the savings Canadians have accumulated during the pandemic are helping to boost spending despite interest rate hikes, he said.
“Some households have cut back as inflation and higher interest rates have eaten away at their budgets, and some are under severe pressure,” says Macklem.
“But for many, greater savings could act as a buffer and support consumer spending.”
The central bank is doing a balancing act
The Bank of Canada fears that if it doesn’t act forcefully now, Canadians will pay the price later, Macklem said.
“The downward momentum of inflation is waning, and we fear that if we are not careful, progress towards price stability could stagnate,” he said.
If the economy sees upside surprises, inflation may actually rise again, Macklem warned.
“We’re trying to balance the risks of under-tightening and over-tightening,” he said.
“We know that if we don’t do enough now, we will probably have to do more later. However, we also know that if we do more than we need now, it will be unnecessarily painful.”
This report from The Canadian Press was first published on July 12, 2023.
