Today, the Bank of Canada announced its decision to maintain the overnight rate at 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. This comes amid a global economic slowdown and ongoing quantitative tightening. As Canadian citizens and residents, it’s imperative to dissect what this decision means for our economy, daily lives, and whether there are any contradictions in the Bank’s stance.
Global Economic Context
Firstly, it’s essential to recognize that the global economic landscape is becoming increasingly challenging. The Bank of Canada’s projection suggests that global GDP growth is expected to reach 2.9% this year, 2.3% in 2024, and 2.6% in 2025. This forecast is somewhat in line with the July Monetary Policy Report, but a shift in the composition of global growth is noteworthy. The United States is displaying economic resilience, while China’s growth has been weaker than expected, and the Eurozone is experiencing a slowdown.
It’s also worth mentioning that inflation, a critical economic indicator, has been easing in many countries. Supply bottlenecks are resolving, and weakened demand is alleviating price pressures. However, the persistence of underlying inflation keeps central banks vigilant. Geopolitical uncertainties, such as the war in Israel and Gaza, add further complexity to the global economic landscape.
The Canadian Perspective
The Bank’s decision to maintain the current interest rates and continue quantitative tightening is rooted in Canadian economic conditions. There is mounting evidence that previous interest rate hikes are having a dampening effect on economic activity while easing price pressures. Notably, consumption has slowed, particularly in the housing and durable goods sectors.
Businesses, too, are feeling the impact, as higher borrowing costs and weaker demand weigh on investments. The surge in Canada’s population is creating a unique situation, where it eases labor market pressures in some sectors while driving up housing demand and consumption. Recent job gains have been slower than labor force growth, but the labor market remains tight, and wage pressures persist. This suggests a delicate balance between supply and demand in the Canadian economy.
Economic Growth and Inflation
The Bank’s outlook for the Canadian economy is sobering. After an average of 1% economic growth over the past year, the forecast anticipates continued weakness for the next year, followed by a pickup in late 2024 and 2025. The sluggish growth is attributed to the repercussions of past interest rate hikes and slower foreign demand. However, the anticipation of increased household spending, stronger exports, and business investments due to foreign demand improvements should contribute to a rebound. Government spending is also expected to play a role in growth over the forecast horizon. In sum, the Bank projects a 1.2% growth rate for 2023, 0.9% in 2024, and 2.5% in 2025.
Inflation has been a rollercoaster in recent months, with rates oscillating between 2.8% and 4.0% before settling at 3.8% in September. The increase in interest rates is gradually moderating inflation in credit-driven purchases, extending to services and particularly food. However, housing-related costs, such as rent and mortgage interest, remain high. Short-term inflation expectations and corporate pricing behavior are slowly returning to normal, with wages maintaining a growth rate of 4% to 5%. Core inflation, as favored by the Bank, remains relatively stable.
In the Bank’s projections, CPI inflation is expected to average around 3½% until the middle of next year before gradually easing to 2% in 2025. The higher near-term path is attributed to energy prices and the ongoing persistence in core inflation.
Bank’s Strategy and Potential Contradictions
The Bank of Canada’s decision to hold the policy rate steady at 5% and continue quantitative tightening reveals a strategy of moderating spending and alleviating price pressures. The Bank aims to restore price stability for Canadians but expresses concern over the slow progress in that direction and increased inflationary risks. The Bank remains ready to raise interest rates further if necessary, contingent on multiple factors such as core inflation, supply and demand balance, inflation expectations, wage growth, and corporate pricing behavior.
While the Bank’s focus on price stability and its readiness to adjust rates as needed is commendable, there may be some contradiction in its stance. It acknowledges that past interest rate hikes have been impacting consumption and business investment negatively. Yet, it continues with quantitative tightening, which, in a way, adds to the tightness in the labor market and keeps borrowing costs high.
The tight labor market is driving wage pressures, but the Bank is also striving for a downward momentum in core inflation. Achieving both objectives simultaneously might prove challenging, and the Bank may need to consider more nuanced measures to ensure economic balance.
In conclusion, the Bank of Canada’s decision is undoubtedly influenced by complex global and domestic economic factors. While it attempts to strike a balance between moderating spending and managing price pressures, there may be a need for a more nuanced approach, especially given the challenges posed by the past interest rate hikes and the delicate economic conditions within Canada. As Canadian citizens, we should keep a watchful eye on how these policies impact our daily lives and financial well-being. The next scheduled date for announcing the overnight rate target is on December 6, 2023, and it will be interesting to see how the Bank’s strategy evolves in the face of these economic challenges.