Canadian economy grew through Omicron wave, boosting chance of Bank of Canada rate hike Wednesday – The Globe and Mail

The Canadian economy continued to grow through the Omicron wave of the COVID-19 pandemic, beating analyst expectations and increasing the likelihood that the Bank of Canada will raise interest rates on Wednesday for the first time since 2018.

Despite another round of health restrictions, preliminary estimates show that Canada’s GDP grew by 0.2 per cent month-over-month in January, Statistics Canada said Tuesday. While economic growth slowed in December, the Canadian economy ended last year on a solid footing, with GDP growing 6.7 per cent on an annualized basis in the fourth quarter.

This data reinforces the overwhelming consensus among economists that the Bank of Canada will hike its policy interest rate on Wednesday. The rate of inflation has been running at a three-decade high in recent months, and central bank officials have been explicit that ultra-low interest rates are no longer appropriate.

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Russia’s invasion of Ukraine adds uncertainty to the global economic outlook, making it harder for central bankers to make monetary policy decisions. From a Canadian perspective, however, the war is likely to add to inflationary pressures as global energy and grain prices spike in response to supply disruptions.

The price of West Texas Intermediate (WTI) crude oil was up 10 per cent Tuesday morning, hitting US$105 per barrel for the first time since 2014. Economic analysis from the Bank of Montreal suggests that every US$10 increase in the price of oil adds around 0.4 percentage points to inflation in Canada and the United States.

The annual rate of consumer price growth in Canada hit 5.1 per cent in January. The central bank’s most recent forecast, from January, projects that inflation will remain close to 5 per cent until the middle of the year before declining to around 3 per cent by the end of the year. That forecast assumes WTI crude will cost US$75 a barrel – much lower than the current or projected price of oil.

Jason Daw, Royal Bank of Canada’s head of North American rates strategy, said that there is little justification for the Bank of Canada to hold off raising its policy interest rate to 0.5 per cent from 0.25 per cent on Wednesday.

“Uncertainty and volatility argues for a less aggressive path [of interest rate hikes], but there are very real inflation risks now and a positive terms of trade impact if the commodity price situation persists,” Mr. Daw wrote in a note to clients.

The Bank of Canada has held its policy rate near zero cent since March, 2020, to boost demand for credit and help support the economy through the pandemic. At the latest rate decision in January, bank Governor Tiff Macklem said that interest rates need to be on a rising path now that both economic output and employment has largely recovered from the pandemic-related recession.

The GDP numbers published Tuesday bolster that argument, with economic output exceeding the central bank’s fourth quarter projections.

Real GDP growth was driven by businesses building up new inventories as supply chain disruptions eased, as well as by increased investment in both residential and nonresidential structures. On the downside, higher international exports were overshadowed by larger increases in imports, while rising prices muted growth in consumer spending, StatsCan said.

“The new news here is that the economy had a bit more momentum than generally expected around the turn of the year and nominal GDP is on a tear,” Bank of Montreal chief economist Douglas Porter wrote in a note to clients. “On balance, this is just another green light for the Bank of Canada to proceed with rate hikes, despite the flashing amber from geopolitical events.”

Analysts and investors expect the central bank to hike its policy rate several times in quick succession, bringing the cost of borrowing back to pre-pandemic levels sometime next year. Before the pandemic, the Bank of Canada’s policy rate was at 1.75 per cent.

The central bank is also expected to provide more information on Wednesday about plans to shrink the size of its balance sheet. It bought hundreds of billions of dollars of Federal Government bonds during the first 18 months of the pandemic as part of a quantitative easing (QE) program, aimed at holding down interest rates. It ended QE in October, but it has not yet begun to shrink its holdings.

Bank officials have said they may start allowing bonds to mature and roll off the balance sheet after the first interest rate hike.

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