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A woman walks past the Bank of Canada headquarters in Ottawa, June 1, 2022.Adrian Wyld/The Canadian Press

Faced with uncertainty about the strength of monetary policy, the Bank of Canada’s governing council debated whether or not to raise interest rates at its July announcement, according to a summary of the discussions – ultimately deciding to take action as insurance against sticky inflation.

On July 12, the bank increased its benchmark rate to 5 per cent, the highest level since April, 2001. A roundup of the debate that preceded the decision, published Wednesday, shows that Governor Tiff Macklem and his team were on the fence about further rate hikes.

There were plenty of signs that inflation was proving more stubborn, and the Canadian economy more resilient, than expected. But the governing council was unsure whether this was because past interest-rate increases were taking longer than expected to work or because they were not sufficiently restrictive.

“The discussion turned to whether it was appropriate to raise the rate in July or wait for more evidence to solidify the case for further tightening. The consensus among members was that the cost of delaying action was larger than the benefit of waiting,” the summary of deliberations says.

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At this point in the fight against inflation, each rate decision is an exercise in risk-management. That means weighing the odds that inflation will get stuck above the bank’s 2-per-cent target against the risk of doing too much and pushing the economy into an unnecessarily painful recession.

That dynamic was also at play in the U.S. Federal Reserve’s rate announcement on Wednesday. The central bank raised the federal funds rate to a range of between 5.25 and 5.5. At the same time, chair Jerome Powell indicated that future decisions about rate hikes would come down to new data and an assessment of risks.

“It’s really a question of how do you balance the two risks: the risk of doing too much or doing too little. We’re coming to a place where there really are risks on both sides. It’s hard to say exactly whether they’re in balance or not,” Mr. Powell said in a press conference after the announcement.

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The Bank of Canada’s summary contains no new information about its plans for the next rate decision on Sept. 6. But it did reiterate Mr. Macklem’s recent comments that the bank is data-dependent, and is willing to raise rates further if economic indicators aren’t heading in the right direction.

“So, here is basically what the bank is grappling with right now. Either policy isn’t tight enough; or it is, but hasn’t been tight enough for long enough,” Robert Kavcic, a senior economist at Bank of Montreal, wrote in a note to clients.

“Our official call is that the Bank is done raising rates. But the risk remains to the upside as their bias is to tighten further; and rate cuts remain a discussion for next year.”

Consumer Price Index inflation has fallen considerably since last summer, reaching an annual rate of 2.8 per cent in June compared with 8.1 per cent a year earlier. At the time of the Bank of Canada’s rate announcement, the latest CPI data showed 3.4-per-cent inflation.

The drop in inflation is a major step in the right direction. However, the bank’s latest economic projection, published this month, extended the timeline to get inflation all the way back to the 2-per-cent target. Central bank economists now believe that this won’t happen until the middle of 2025, two quarters later than previously expected.

“With inflation projected to be around 3 per cent for the next year and with the upside risks to inflation expectations and household spending, governing council members were concerned that the progress toward price stability could stall, and inflation could even rise again if upside surprises materialize,” the summary says.

“Members agreed that there was considerable uncertainty around the outlook for inflation given the persistence of core inflation and countervailing forces supporting demand.”

The fact that the bank is still hiking interest rates at all is owing to the surprising resilience of the Canadian economy. The bank paused rate hikes in January, but jumped back into action in June after seeing stronger-than-expected consumer spending, inflation and labour market data.

The bank’s summary points to several factors that are bolstering consumer demand, including high wage growth, accumulated household savings and strong population growth, fuelled by immigration.

The relationship between high levels of immigration and inflation, in particular, has become a major topic of debate among economists. The governing council spent time discussing the issue, the summary says, determining that population growth had both helped relieve labour shortages and added to demand for goods and housing.

“Members agreed that it was difficult to assess with precision the net effect of population growth on excess demand, but they viewed the first-order effect as roughly neutral,” the summary says.

The governing council expects consumer spending to cool as its earlier rate hikes move through the economy. Interest-rate increases work with a lag, as homeowners with fixed-rate mortgages reset at higher rates, leaving them with less money for discretionary spending.

“But this moderation will take longer than previously anticipated given the stronger-than-expected momentum in consumption in the second quarter and the combination of a still-tight labour market with accumulated savings by households.”

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