OTTAWA—The Bank of Canada raised its key interest rate by a quarter of a percentage point (25 basis points) to 4.5 percent on Jan. 25, and indicated that it expects that its rate-hiking cycle is complete, barring any significant future economic surprises.
“If economic developments evolve broadly in line with the MPR [monetary policy report] outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases,” the Bank of Canada said.
The central bank has now raised rates by 425 basis points in less than a year.
The BoC says that the economy continues to operate in a state of excess demand, which is still putting upward pressure on many prices, and that recent economic performance has been stronger than projected. The central bank estimates that the Canadian economy grew by 3.6 percent in 2022.
The bank is not forecasting a recession in 2023, with growth projected to stall at around 1 percent before strengthening to about 2 percent in 2024.
The BoC reiterated that it expects inflation to be back at its 2 percent target in 2024, and that by mid-2023, it should come down to around 3 percent.
Inflation Moving in Right Direction
Inflation is showing signs of losing steam. From a peak of 8.1 percent in June, it has steadily come down to 6.3 percent in December. Excluding more variable items like food and energy, prices rose 5.3 percent on a yearly basis in December—down from 5.4 percent in November.
The bank points to three-month measures of core inflation coming down as suggesting that core inflation has peaked.
The BoC said the biggest reasons for the decline in inflation are that gas prices have dropped more than expected—by about $2 per litre in June 2022 to about $1.50 per litre in January 2023—and global supply chains have improved more quickly than anticipated.
Housing market activity has taken the biggest hit thus far from the 400 basis points of rate hikes in 2022. It is the largest detractor from domestic demand in the economy—estimated at 1 percent in 2022 and -0.7 percent in 2023. By 2024, housing is expected to contribute positively to demand.
The BoC says that interest payments on household mortgages are estimated to climb to 4.5 percent of disposable income at the start of 2023, up from 3.2 percent a year earlier. This figure is expected to rise further as homeowners renew their mortgages at higher rates.
Consumers are feeling the pain of higher rates and the bank forecasts that consumption’s contribution to domestic demand will fall from 2.7 percent in 2022 to 0.7 percent in 2023. Consumer confidence indicies, which are around levels seen during the first lockdown in early 2020, are expected to restrain household spending.
According to the bank’s business outlook survey, most businesses surveyed expect a mild recession. They’re seeing new orders and sales inquiries weaken and they’re thus tempering their investment and hiring intentions.
Businesses and consumers expect inflation to run higher than what the BoC is forecasting over the next two years.
On Feb. 8, the BoC will provide—for the first time ever—a summary of the debate among its governing council on how the Jan. 25 interest rate decision was reached, in the interest of greater transparency.
