Bank of Canada Pauses as GDP Slips but Remains Worried About Inflation
After tightening in two straight meetings (June and July) after two straight pauses (March and April) the Bank of Canada decided to leave rates unchanged, as was widely expected. The statement sees slowing economic activity but stubborn inflation, but the BoC is prepared to give the slower activity some time to feed into inflation.
The BoC stated that given signs of easing excess demand and given policy lags they decided to hold the rate at 5.0% but they go on to say that they are concerned about persistent underling inflationary pressures and are prepared to tighten further if needed. While we expect the BoC to keep rates at 5.0% until easing commences in Q2 2024 this is data dependent and either a fresh acceleration in activity or stubbornly strong inflationary data would be enough to have the BoC considering a fresh tightening.
On activity, the BoC states that the economy has entered a period of weaker growth, which suggests a reasonable degree of confidence that the 0.2% annualized decline in Q2 GDP will not prove erratic. We expect GDP growth to be subdued going forward, but we do not believe the data signals the start of a recession. Domestic demand grew by 1.0% in Q2, similar to Q1’s 1.2%, when GDP rose by a healthy 2.6%.
The BoC’s tone on inflation is cautious, seeing 3-month annualized and yr/yr core inflation measures running at a pace of around 3.5%, indicating little recent downward momentum, adding the longer this persists the greater the risk it becomes entrenched. Inflation is seen rising in the near term on higher gasoline prices before easing again. The BoC will clearly be watching forthcoming inflationary data, particularly the core measures, with some anxiety. Our forecast of no more rate hikes assumes the data will provide the BoC with some relief.