Bank of Canada Increases Key Interest Rate to 5% while Expressing Concerns about Lingering Inflation
In a recent development, the Bank of Canada announced a 25 basis points hike in its key interest rate, bringing it to 5%. Addressing university students, the central bank warned that the process of taming inflation might take longer than anticipated. This move comes as no surprise to economists, as it is the second rate hike following the pause the bank took in June. In its statement, the Bank acknowledged the resilience of Canada’s economy, highlighting its strength and a tight labor market with wage growth ranging from 4% to 5%.
The Bank’s policymakers expect a slowdown in growth as the increased interest rates gradually affect the economy. According to their July Monetary Policy Report, they predict real GDP growth of 1.8% for this year and 1.2% for 2024. However, inflation remains a concern. Although the consumer price index dropped from its peak of 8.1% last summer to 3.4% in May, the decline is mainly attributed to lower energy prices. Core inflation, which has remained around 3.5% to 4%, has proven to be more persistent than anticipated, as confirmed by the Bank’s Business Outlook Survey, with businesses reporting more frequent price increases.
The Bank now foresees that price growth will not return to its target until mid-2025, extending the timeline by about six months. The statement expressed the Governing Council’s worries about the potential stalling of progress towards the 2% inflation target, jeopardizing the achievement of price stability.
Following the announcement, the Canadian dollar saw a rise to its highest intraday level since June 27, reaching 76 US cents. Meanwhile, the benchmark two-year yield dropped further to 4.675% after initially plummeting due to lower-than-expected U.S. inflation rates.
Bank of Canada Governor Tiff Macklem stated in a news conference that this may not be the last rate increase. He emphasized the Bank’s willingness to take further action if new information suggests it is necessary. However, Macklem noted that decisions on future rate adjustments will be influenced by incoming data and the outlook for inflation. The Bank aims to see a slowdown in demand growth, moderation in wage pressures, and normalization of corporate pricing behavior before considering further actions.