Bank of Canada Would Consider Tightening Further if Inflation Remains Stubborn
The Bank of Canada’s 25bps tightening to 5.0% was as expected, but the tone of the statement was hawkish, in particular taking a more pessimistic view on inflation than had been the case in its January and April Monetary Policy Reports. At the press conference however, Governor Tiff Macklem was more balanced, meaning that while further BoC tightening is a significant risk, we still expect this move to prove the last.
The statement welcomed a slower May CPI outcome but saw downward momentum in inflation as largely from energy. It added that with three-month core rates rising around 3.5-4.5% since September underlying price pressures appear more persistent than anticipated. The BoC now sees inflation running around 3% for the next year before gradually returning to the 2% target in the middle of 2025, a slower decline than had been previously forecast, with the BoC remaining concerned that progress could stall.
The BoC also noted that the Canadian economy has been stronger than expected, noting strength in consumption and a pick-up in housing, though still expects growth to slow, with the economy moving into modest excess supply in early 2024, before regaining momentum in 2025.
The concluding language in the statement was exactly the same as in June, with the BoC to evaluate whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behavior are consistent with achieving the 2% target.
At his press conference Governor Macklem reiterated all these arguments for the tightening, but he did say that the BoC had considered holding rates and waiting for more information, and that the BoC was trying to balance the risks of over-tightening and under-tightening. He said the BoC is prepared to tighten further, but did not want to more than was needed.
We still expect rates to be held at 5.0% through Q1 2024, before 25bps of easing is seen in each of Q2, Q3 and Q4 of 2024, but this requires progress being seen on inflation. Encouraging signals in today’s US CPI for June raise hopes that similar signals can be seen in Canada. However, today’s BoC statement does suggests significant risk that if inflation continues to prove stubborn, more may still be done, and the BoC could keep rates higher for longer. Macklem said he thought that the BoC was close to the end of the tightening cycle, but it was too early to be talking about rate cuts.
I,Dave Sloan, the Senior Economist declare that the views expressed herein are mine and are clear, fair and not misleading at the time of publication. They have not been influenced by any relationship, either a personal relationship of mine or a relationship of the firm, to any entity described or referred to herein nor to any client of Continuum Economics nor has any inducement been received in relation to those views. I further declare that in the preparation and publication of this report I have at all times followed all relevant Continuum Economics compliance protocols including those reasonably seeking to prevent the receipt or misuse of material non-public information.