BoC Hikes Policy 25bp to 4.50%; Prime Follows

The Bank of Canada has announced it has:

today increased its target for the overnight rate to 4½%, with the Bank Rate at 4¾% and the deposit rate at 4½%. The Bank is also continuing its policy of quantitative tightening.

Global inflation remains high and broad-based. Inflation is coming down in many countries, largely reflecting lower energy prices as well as improvements in global supply chains. In the United States and Europe, economies are slowing but proving more resilient than was expected at the time of the Bank’s October Monetary Policy Report (MPR). China’s abrupt lifting of COVID-19 restrictions has prompted an upward revision to the growth forecast for China and poses an upside risk to commodity prices. Russia’s war on Ukraine remains a significant source of uncertainty. Financial conditions remain restrictive but have eased since October, and the Canadian dollar has been relatively stable against the US dollar.

The Bank estimates the global economy grew by about 3½% in 2022, and will slow to about 2% in 2023 and 2½% in 2024. This projection is slightly higher than October’s.

In Canada, recent economic growth has been stronger than expected and the economy remains in excess demand. Labour markets are still tight: the unemployment rate is near historic lows and businesses are reporting ongoing difficulty finding workers. However, there is growing evidence that restrictive monetary policy is slowing activity, especially household spending. Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially. As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment are expected to slow. Meanwhile, weaker foreign demand will likely weigh on exports. This overall slowdown in activity will allow supply to catch up with demand.

The Bank estimates Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in October. Growth is expected to stall through the middle of 2023, picking up later in the year. The Bank expects GDP growth of about 1% in 2023 and about 2% in 2024, little changed from the October outlook.

Inflation has declined from 8.1% in June to 6.3% in December, reflecting lower gasoline prices and, more recently, moderating prices for durable goods. Despite this progress, Canadians are still feeling the hardship of high inflation in their essential household expenses, with persistent price increases for food and shelter. Short-term inflation expectations remain elevated. Year-over-year measures of core inflation are still around 5%, but 3-month measures of core inflation have come down, suggesting that core inflation has peaked.

Inflation is projected to come down significantly this year. Lower energy prices, improvements in global supply conditions, and the effects of higher interest rates on demand are expected to bring CPI inflation down to around 3% in the middle of this year and back to the 2% target in 2024.

With persistent excess demand putting continued upward pressure on many prices, Governing Council decided to increase the policy interest rate by a further 25 basis points. The Bank’s ongoing program of quantitative tightening is complementing the restrictive stance of the policy rate. If economic developments evolve broadly in line with the MPR outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases. Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.

The Monetary Policy Report has also been made available.

David Parkinson points out:

The Bank of Canada warned that although the pace of wage growth “appears to have plateaued” in the range of 4 to 5 per cent annually, it remains a threat to achieving a return to its 2-per-cent inflation target.

In its Monetary Policy Report, the bank didn’t mince words.

“Unless a surprisingly strong pick-up in productivity growth occurs, sustained 4 per cent to 5 per cent growth is not consistent with achieving the 2-per-cent inflation target.”

Think of a sustainable pace for wage growth as the rate of productivity growth plus the rate of inflation.

So, you would need productivity to grow by between 2 and 3 per cent annually to support this sort of wage growth while sustaining 2-per-cent inflation. Labour productivity grew 0.6 per cent in the third quarter compared to the second quarter (the latest figures available from Statistics Canada), but actually declined 0.3 per cent year over year.

The implication is that if wage growth doesn’t retreat, barring a surge in productivity, the bank’s quest for 2-per-cent inflation will run into a road block – and higher interest rates for longer may be necessary to achieve the target.

Prime followed:

Well, Rob Carrick and Ryan Siever will be mad:

There’s a case to be made for banks giving borrowers a break when what is expected to be the biggest interest rate hike in 22 years is announced on Wednesday.

A brief flashback to 2015 is required to get the sense of this story. The economy back then was in the opposite shape of what it is now – weak enough to prompt the Bank of Canada to cut its trendsetting overnight rate by 0.25 of a percentage point in January and again in July.

The big banks hijacked part of that rate cut. While the overnight rate fell by a total 0.5 of a point, the banks cut their prime rate by cumulative 0.3 of a point. They held back the rest of the rate cut to build their revenues and profit.

There was a delay in reducing the prime when the Canada Overnight rate dropped 25bp to 0.75% in January 2015 and again when Canada Overnight dropped a further 25bp to 0.50% in July of that year.

One Response to “BoC Hikes Policy 25bp to 4.50%; Prime Follows”

  1. DR says:

    when i first started using TD’s HISA (TDB8150) for my cash management, it was 25bps over the o/n rate. as of this morning it is now 70 thru, granted they take a few days to adjust but suspect will be 50 thru.

    granted the prime-o/n spread widening affects more people the magnitude of widening is much higher on the depo side

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