Bank of Canada raises key interest rate to 5%, highest since 2001 – The Globe and Mail

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The Bank of Canada has increased its benchmark interest rate to 5 per cent and pushed out the timeline for getting consumer prices under control, warning that the downward momentum of inflation could stall over the next year as the economy proves surprisingly resilient to higher borrowing costs.

The quarter-point increase, which was widely expected by analysts, brings the policy rate to a level last seen in April, 2001. This will further squeeze Canadians’ finances and push up costs for mortgage holders.

In an updated forecast, the central bank said it expects the annual rate of inflation to remain around 3 per cent for the next year, declining to the bank’s 2-per-cent target by the middle of 2025.

“This is a slower return to target than was forecast in the January and April projections,” the bank said in its rate announcement. “Governing council remains concerned that progress towards the 2-per-cent target could stall, jeopardizing the return to price stability.”

The bank gave no hints about future rate decisions but left the door open to further hikes.

“We are trying to balance the risks of over- and under-tightening,” Bank of Canada governor Tiff Macklem said in a news conference after the decision. “If new information suggests we need to do more, we are prepared to increase our policy rate further. But we don’t want to do more than we have to.”

Canadian bond yields fell after the announcement, suggesting that markets were expecting a more explicit signal about further rate hikes.

Mr. Macklem and his team are grappling with the surprising strength of the Canadian economy. Many analysts expected the economy to be in a recession by now, squeezed by the most aggressive interest rate increases in a generation. However, consumer spending, job creation and the housing market have turned out to be less responsive to rate hikes than anticipated.

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The bank raised its economic growth forecast for 2023 to 1.8 per cent from a previous forecast of 1.4 per cent. It expects GDP growth to slow to around 1 per cent in the second half of this year and first half of next year, but predicts the economy will avoid an outright contraction or recession.

The resilience of the economy has been good for many workers and businesses. But it’s become a headache for central bankers, who are intentionally trying to slow spending and investment to reduce upward pressure on prices and stabilize the purchasing power of the Canadian dollar.

“Today’s move can be characterized as a moderately hawkish hike, in that the BoC is certainly not closing the door on the possibility of further moves,” Bank of Montreal chief economist Doug Porter wrote in a note to clients.

“While we are not looking for further hikes this year, we are tweaking our rate call in light of the Bank’s view on growth and inflation – we now see rate cuts beginning only in the second quarter of 2024, one quarter later than our prior view,” he wrote.

The bank paused its monetary policy tightening campaign in January, betting that it had raised interest rates enough to bring inflation down over time. Interest rate increases work with a lag, and Canada’s highly indebted economy was thought to be more sensitive to rising debt-servicing costs than many other economies.

By June, this “conditional pause” seemed untenable. Consumer spending grew a massive 5.8 per cent in the first quarter and house prices began to rebound through the spring. Meanwhile, Canadian employers added almost 300,000 jobs through the first half of the year, keeping the unemployment rate near a record low.

“We have been surprised by the persistence of excess demand and underlying inflation in Canada and globally. We know that higher rates are having an impact, but how big their impact will be is uncertain,” Mr. Macklem told reporters.

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Consumer price index inflation has come down significantly, reaching 3.4 per cent in May from a four-decade high of 8.1 per cent last summer. But most of this decline has come from year-over-year comparisons in the price of oil, which spiked after Russia’s invasion of Ukraine last year and has moderated since then.

Core measures of inflation, which strip out more volatile energy and food prices, have been stickier, with three-month rates averaging around 3.5 to 4 per cent. That suggests the next leg down in inflation could take longer than previously expected.

“With the downward momentum in inflation waning and our forecast suggesting inflation will be around 3 per cent for the next year, we are concerned that the progress to price stability could stall, and inflation could even rise again if there are upside surprises,” Mr. Macklem said.

The bank pointed to several factors behind the surprisingly strong demand in the economy, including high population growth, a tight labour market, accumulated savings and spending by federal and provincial governments.

Another rate increase means more financial pain for Canadian households, who face higher costs to service their debt.

So far, signs of acute financial strain remain relatively limited, the bank said in a special section of its quarterly Monetary Policy Report, published Wednesday. Delinquency rates are rising but remain below pre-pandemic levels, even for variable-rate mortgage holders who have been squeezed the most by rising interest rates.

But there are some pockets of concern, the bank said.

“Credit card data show that borrowers are using their credit cards more extensively than they have in the past,” it said.

“In addition, although overall delinquency rates on loans remain relatively low, the share of borrowers moving from 60 to 90+ days late on any credit product has risen and is now close to a historical high.”

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Many homeowners have been cushioned against rising rates because their lenders have let them extend the amortization periods of their mortgages rather increasing their monthly payments. The bank noted that only one-third of mortgage holders have been affected by higher rates so far.

“As this share increases over the coming quarters, more households will face higher debt-service costs. Mortgage holders with variable-rate fixed payments could be particularly exposed,” the bank said.

The bank’s next interest rate decision is scheduled for Sept. 6.

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