OTTAWA—After the Bank of Canada announced a pause on interest rate hikes in January, it continued to stay true to its word on April 12 by holding its overnight rate target at 4.5 percent, which was widely expected. Forecasts for much weaker but still positive economic growth were shifted further into the future after a robust first quarter of 2023.
The BoC’s inflation outlook for 2023 and 2024 remained broadly unchanged, but there is no longer any talk of economic growth stalling through the first half of 2023, as there was in January. However, the bank says that after a stronger-than-expected first quarter, growth will average less than 1 percent for the rest of 2023.
The central bank reiterated its prior expectation on inflation—namely that it will come down rapidly to 3 percent by mid-2023 and decline more steadily to the 2 percent target by the end of 2024.
But the central bank said it “remains prepared to raise the policy rate further” as it assesses if the 4.25 percentage points of rate increases since last March are sufficient to bring inflation back to target.
“Getting inflation the rest of the way back to 2 percent could prove to be more difficult,” the Bank of Canada said in its April 12 statement.
This is due to wage growth and service price inflation remaining elevated, expectations for future inflation from businesses and consumers coming down more slowly, and corporate pricing behaviour which has yet to normalize.
No Surprises With Inflation
February’s annual inflation rate came in at 5.2 percent, which declined from January’s 5.9 percent—the largest deceleration in inflation since April 2020.
But the central bank noted that three-month inflation has fallen to about 1.6 percent, suggesting annual inflation will continue to drop in the near term. Also, core inflation, which excludes the more volatile components like food and energy, has come down to around 3.5 percent for its three-month reading.
The BoC released a new set of quarterly forecasts in its Monetary Policy Report (MPR) that essentially brought forward some economic growth from 2024 into 2023 as compared to January’s forecast.
The bank projects economic growth of 1.4 percent for 2023—up from 1.0 percent in January. The growth forecast for 2024 fell sharply from 2 percent to 1.3 percent.
The bank upgraded its forecast for first quarter growth significantly to 2.3 percent up from just 0.5 percent in January.
The bank says the reasons for the robust first-quarter growth are a surge in exports due to a large harvest and an increase in population and consumption. There is also a timing issue with the fourth quarter of 2022 economic growth coming in weaker than forecast and some of that economic activity getting captured in early 2023.
The Bank of Canada updated its estimate for the potential output growth of the economy to 2.0 percent from 1.4 percent. This means there is additional room in the economy to grow without adding to inflation; however, the economy is still operating at a level of excess demand, labour shortages, and rising wages.
The totality of fiscal policy, which includes Budget 2023 and the provincial budgets, is adding about $25 billion a year for the next three years in stimulus through spending and tax cuts, but the bank says this is not adding to inflationary pressures due to a higher potential output growth rate for the economy.
Another phenomenon that the Bank of Canada touched on was the U.S. banking turmoil, which is leading to more restrictive lending conditions south of the border, particularly with regional banks.
The central bank said this stress in U.S. regional banking will weigh on U.S. growth this year and next.
However, the BoC expects the U.S. Federal Reserve to raise interest rates further due to higher-than-expected inflation as compared to the BoC’s prior projections.
