The relevance of this new increase, of 25 basis points, will be debated. But this time, a pause is anchored with a key rate at 4.5%. A conditional break, however, warns the Bank of Canada, which takes a disapproving look at wage increases.
“We expect to maintain the policy rate at the current level while we assess the impact of its cumulative increase of 425 basis points. We have raised rates quickly, and now is the time to pause to assess whether monetary policy is tight enough to bring inflation back to the 2% target,” Bank of Canada Governor Tiff said on Wednesday. Macklem. “I want to make it clear that this is a conditional break; it will only take place if the evolution of the economy is generally in line with the outlook presented in the Report [sur la politique monétaire]. »
Was this additional increase, an eighth since March 2022, necessary? Yes, tells us the central bank, which speaks of an economy still overheating. Among the risks listed in the Monetary Policy Report, also published on Monday, it raises that of service price inflation not adjusting as quickly as expected. Also, the growth in labor costs could be higher and more persistent. “There are few signs that labor market tensions are easing. The number of vacancies has fallen slightly, but remains high, the unemployment rate is near historical lows and many companies continue to report labor shortages.
“Wage growth remains widespread and appears to be holding between 4% and 5%. […] Unless productivity growth becomes surprisingly strong, it will not be possible to meet the 2% inflation target if wage growth remains within this range,” she warns.
As for the inflation of the prices of services, the increase in the cost of money should do its work and weigh on discretionary spending. “Interest payments on household mortgages are estimated to be around 4.5% of disposable income at the start of 2023, compared to 3.2% at the same time in 2022.” This weight is expected to continue to increase as homeowners renew their loan. “The low level of consumer confidence and the decline in household wealth […] will also restrain spending,” the report continues.
All this while measures of so-called core inflation, which ignores temporary deviations from inflation measured by the Consumer Price Index (CPI), are stuck around 5%.
In the background, however, the Bank of Canada has revised its inflation growth target to 3.6% in annual variation this year, against 4.1%, which was expected in the October Monetary Policy Report. . It also publishes a graph — which accompanies the text by my colleague Éric Desrosiers — showing a sharp deceleration in inflation since May, according to a more current measure of inflation based on the three-month change in the CPI. For the institution, the fact that the three-month rates are below the one-year increases means that core inflation should drop from 5% and begin its descent.
More serious recession?
This chart also supports economists’ thesis that the Bank of Canada should have taken a break in January. Oxford Economics reminds us that the Canadian economy is highly sensitive to rising interest rates due in particular to high household debt and overvalued residential real estate prices. For the research firm, the Canadian economy is already in the early stages of the recession.
For the National Bank, the rise was already steep and sufficient. Taking inspiration from recent economic indicators, the drop in consumer and business confidence and the degree of inversion of the yield curve, analysts at National believe that the Bank of Canada has now gone too far in its monetary austerity campaign. They add that the central bank may be surprised by how quickly inflation returns to target, which they see somewhere in the second half of 2023.
On the recession side, economic activity will be weaker than the central bank expects. Moreover, the economists invited to the winter retreat of Justin Trudeau’s cabinet in anticipation of the return to parliament urged ministers to prepare for a major slowdown.
According to comments collected by The Canadian Press on Tuesday, “we can expect the economy to slow considerably. We can expect the unemployment rate to rise,” said former Bank of Canada deputy governor and senior fellow at Princeton University’s Griswold Center for Economic Policy Studies, Carolyn A. Wilkins.
There are “serious risks”, added Kevin Milligan, professor of economics at the University of British Columbia. A report by former Bank of Canada Governor David Dodge and former Liberal financial policy adviser Robert Asselin calls for a “high likelihood of a deeper recession” this year.