Bank of Canada hikes interest rates to 22-year high

The second increase in as many months comes on the back of persistent inflation and excess consumer spending.

Gary Haines of Cycle World Superstore places a SOLD sign on a Harley Davidson motorcycle that had been purchased by a customer in Toronto, Ontario, Canada
Surprisingly persistent demand is one of the factors fuelling inflation in Canada [File: Chris Helgren/Reuters]

The Bank of Canada (BoC) has hiked its key overnight interest rate by a quarter of a percentage point to a 22-year high of 5 percent, saying it feared that efforts to return inflation to its 2 percent target could stall amid excess consumer spending.

The move on Wednesday increased borrowing costs by 25 basis points for the second time in as many months and was expected by analysts and markets. After a five-month pause, the BoC raised its overnight rate in June, saying monetary policy was not sufficiently restrictive.

In a statement on Wednesday, the BoC dropped the line saying rates were not restrictive enough, but it raised its growth forecast for this year and pushed back its expectations for getting inflation to its target by six months to mid-2025.

BoC governing council members “still sound open to further tightening”, said Derek Holt, vice president of capital markets economics at Scotiabank. “So I think they’re just taking the summer off.”

Canadian money markets increased bets for another rate increase after the move, seeing an almost 40 percent probability of another hike at the next policy announcement in September.

“With three-month measures of core inflation running in the 3.5 percent to 4 percent range for several months and excess demand persisting, concerns have increased that CPI [consumer price index] inflation could get stuck materially above the 2 percent target,” the BoC said in a statement.

Despite nine previous rate increases totaling 450 basis points since March of last year, the economy regained momentum in May, likely growing 0.4 percent on the month, after stalling in April.

“They are done for now [with more hikes]. However, today’s tone does communicate a risk of another possible hike in September,” said Andrew Kelvin, chief Canada strategist at TD Securities.

The BoC raised its forecast for second-quarter annualized growth to 1.5 percent from 1 percent in April, and growth is seen expanding 1.5 percent also in the third quarter. Overall, 2023 real gross domestic product growth is seen at 1.8 percent compared with its April forecast of 1.4 percent.

“The rebalancing of supply and demand is now expected to happen in early 2024,” the BoC said it its report containing the new forecasts also released on Wednesday.

Although headline inflation slowed to 3.4 percent in May, less than half of last year’s 8.1 percent peak, the three-month annualized rates of the BoC’s core measures have not been coming down.

Surprisingly persistent demand, higher-than-expected housing costs and a more gradual decline than expected in goods prices, excluding food and energy, are fueling inflation, the BoC said.

“Inflation is expected to return to 2 percent in the middle of 2025, although the timing is uncertain given the gradual movement of inflation toward the target,” the BoC said.

The BoC’s overnight target rate was last at 5 percent in March and April of 2001.

Twenty of 24 economists surveyed by Reuters had expected the central bank to lift rates by a quarter of a percentage point. Money markets had seen a more than a 70 percent chance of a rate hike before the announcement.

Source: Reuters