The Bank of Canada surprised markets by ending its pause and hiking its key interest rate a quarter percentage point to 4.75 per cent on June 7.
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The central bank pointed to stubbornly high inflation and a resilient Canadian economy as the reasons why the governing council decided its monetary policy was not yet restrictive enough to bring growth in the consumer price index back to its two per cent target.
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“Canada’s economy was stronger than expected in the first quarter of 2023, with GDP growth of 3.1 per cent,” and consumer spending remained high, the Bank of Canada said in a statement.
“The labour market remains tight: higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour. Overall, excess demand in the economy looks to be more persistent than anticipated.”
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The central bank also pointed to strength in the housing market, which has been heating up as homebuyers came off the sidelines during the spring.
The timing of the decision to hike rates was a surprise, though many economists and the market had expected an increase at some point over the summer. July 12 was seen as the most likely meeting for the hike.
The consumer price index, Canada’s main gauge on prices for goods such as groceries and fuel, accelerated to an annualized pace of 4.4 per cent in April, up from a 4.3 per cent pace a month earlier and surpassing economist expectations of 4.1 per cent. It was the wrong direction for the central bank and a far cry from its two per cent target.
Royce Mendes, managing director and head of macro strategy at Desjardins, said when there’s one hike, there are likely more to follow.
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“Monetary policymakers will be watching the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour in deciding whether rates need to move even higher,” Mendes said in a note following the announcement.
“That said, it’s unlikely they’ll see enough progress towards restoring price stability before their next scheduled rate decision for this to be the final hike of the cycle.”
Mendes said his team is leaning toward another quarter-percentage-point hike at the central bank’s next policy meeting in July, bringing the rate up to five per cent.
Canadian Imperial Bank of Commerce economists said the move was justified given the Canadian economy’s unexpected strength and also argued that the hike could leave the door open for more.
The Bank of Canada’s policy rate stood at 0.25 per cent in March 2022, meaning the hiking cycle now totals 450 basis points.
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