oday, the Bank of Canada announced an increase in its target for the overnight rate to 5%, along with the Bank Rate at 5¼% and the deposit rate at 5%. The central bank is also continuing its policy of quantitative tightening.
Globally, inflationary pressures are easing due to lower energy prices and a decline in goods price inflation. However, there are persistent inflationary pressures in services due to robust demand and tight labor markets. Economic growth has been stronger than expected, particularly in the United States, where consumer and business spending has remained resilient. China’s economic growth is softening, with slowing exports and weakness in its property sector. In the euro area, growth has effectively stalled, with contraction in manufacturing offsetting growth in the service sector. Global financial conditions have tightened, with bond yields increasing in North America and Europe as major central banks signal potential interest rate hikes to address inflation.
The Bank’s July Monetary Policy Report (MPR) projects global economic growth of around 2.8% for this year and 2.4% in 2024, followed by 2.7% growth in 2025.
Canada’s economy has been stronger than anticipated, with strong momentum in demand. Consumer spending grew by 5.8% in the first quarter, and while the Bank expects it to slow in response to the cumulative increase in interest rates, recent data indicates persistent excess demand in the economy. The housing market has also seen some pickup, with demand outpacing new construction and real estate listings, putting upward pressure on prices. Although there are signs of increased worker availability in the labor market, conditions remain tight, and wage growth has been around 4-5%. Strong population growth from immigration is contributing to both demand and supply, easing labor shortages, boosting consumer spending, and driving housing demand.
As higher interest rates continue to take effect, the Bank expects economic growth to slow, averaging around 1% in the second half of this year and the first half of next year. This implies real GDP growth of 1.8% in 2023 and 1.2% in 2024. The economy is projected to move into modest excess supply early next year before growth picks up to 2.4% in 2025.
Inflation in Canada has eased to 3.4% in May, a significant drop from its peak of 8.1% in the previous summer. While the decrease in CPI inflation was largely expected this year, it has been driven more by lower energy prices than by easing underlying inflation. With the large price increases from the previous year no longer impacting the annual data, the downward momentum in CPI inflation is expected to be less pronounced in the near term. Additionally, core inflation rates have been running around 3½-4% since September, indicating more persistent underlying price pressures than anticipated. Business surveys conducted by the Bank also indicate that businesses are raising their prices more frequently than usual.
The July MPR projection forecasts CPI inflation to hover around 3% for the next year before gradually declining to 2% by mid-2025. This represents a slower return to the Bank’s inflation target compared to previous projections. The Governing Council of the Bank remains concerned that progress towards the 2% target could stall, risking the return to price stability.
Considering the accumulation of evidence suggesting persistent excess demand and elevated core inflation, and taking into account the revised outlook for economic activity and inflation, the Governing Council decided to increase the policy interest rate to 5%. Quantitative tightening measures are complementing the restrictive monetary policy stance and normalizing the Bank’s balance sheet. The Governing Council will continue to assess core inflation dynamics and the outlook for CPI inflation, focusing on factors such as excess demand, inflation expectations, wage growth, and corporate pricing behavior. The Bank remains committed to restoring price stability for Canadians.
It is important to note that the next scheduled announcement for the overnight rate target is on September 6, 2023. The Bank will release its next comprehensive outlook for the economy and inflation, including risk assessments, in the Monetary Policy Report on October 25, 2023.