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Bank of Canada Governor Tiff Macklem is seen during a press conference in this file photo. On Wednesday, the central bank left interest rates unchanged.Sean Kilpatrick/The Canadian Press

The Bank of Canada has hit pause on its campaign of interest-rate increases, holding its policy rate steady at 5 per cent in response to growing signs the Canadian economy has begun to stall.

At the same time, the central bank said it remains concerned about stubborn inflation and warned of future rate increases if consumer prices begin to accelerate again.

Wednesday’s widely anticipated decision offers some respite to homeowners and other borrowers who have been hammered by rising interest payments over the past year-and-a-half. The bank has raised interest rates 10 times since March, 2022, including twice over the summer, in an effort to slow down spending and investment throughout the economy to reduce upward pressure on prices.

Inflation remains above the central bank’s 2-per-cent target, with annual consumer price index growth clocking in at 3.3 per cent in July. But surprisingly weak economic data over the past month has given the bank confidence to move back to the sidelines and wait for past interest rate increases to work their way through the economy.

Live updates: Bank of Canada holds key interest rate steady at 5%

“With recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy, Governing Council decided to hold the policy interest rate at 5 per cent,” the bank said in its rate announcement. However, bank officials “remain concerned about the persistence of underlying inflationary pressures,” and are “prepared to increase the policy interest rate further if needed,” it said.

Finance Minister Chrystia Freeland praised the bank’s decision, calling it a “welcome relief for Canadians.” The statement was highly unusual given the norms of central bank independence: Federal ministers typically refrain from commenting directly on monetary policy to avoid being seen as unduly influencing the Bank of Canada’s decisions.

The bank has come under increasing political pressure as rising interest rates have squeezed people’s budgets and made home ownership even less affordable. In recent days, the premiers of British Columbia, Ontario and Newfoundland and Labrador all sent letters to the bank urging it to stop raising interest rates.

Most private-sector economists and bond traders are betting that Canadian interest rates have peaked, and the debate on Bay Street has shifted toward how long the central bank will keep rates at the current elevated level – the highest they’ve been since 2001. Most analysts don’t expect the bank to start cutting rates until at least the second quarter of next year.

“The bank has certainly left the door ajar to the possibility of more hikes, but unless growth rebounds in Q3 [the third quarter] – which we doubt – the BoC is likely done with rate hikes,” Bank of Montreal chief economist Douglas Porter said in a note to clients.

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Bank of Canada Governor Tiff Macklem and his team stopped well short of declaring mission accomplished; the one-page rate-announcement maintained fairly hawkish language throughout. This might be to prevent a rerun of the spring, when financial conditions loosened and real estate prices surged after Mr. Macklem’s announcement of a “conditional pause” in January. The bank ultimately ended that pause in June, and hiked again in July.

The decision to pause monetary policy tightening this week was made amid growing evidence that, in the words of the central bank, “the Canadian economy has entered a period of weaker growth.”

Statistics Canada published gross domestic product data last week, showing the Canadian economy contracted at an annualized rate of 0.2 per cent in the second quarter. The bank was expecting 1.5-per-cent annualized growth.

“This reflected a marked weakening in consumption growth and a decline in housing activity, as well as the impact of wildfires in many regions of the country,” the bank said.

The labour market is also showing signs of cooling. The unemployment rate has increased by half a percentage point over the past three months as the pace of job creation has fallen short of rapid, immigration-led population growth. The number of job vacancies has fallen considerably from a peak last year.

Over time, slower economic growth and job creation should feed through into lower inflation. However, “the very near-term inflation outlook isn’t very comforting, and the bank is undoubtedly going to remain on the defensive,” National Bank of Canada economists Taylor Schleich and Warren Lovely wrote in a note to clients.

Headline inflation has fallen sharply since last summer, when annual CPI growth hit a four-decade high of 8.1 per cent. But it ticked higher from June to July. And core inflation measures, which strip out volatile price movements, are running around 3.5 per cent, “indicating there has been little recent downward momentum in underlying inflation,” the bank said.

“Rising gas prices and negative base effects put upward pressure on inflation in August and fresh data in two weeks is likely to show the CPI up nearly 4 per cent year-on-year,” Mr. Schleich and Mr. Lovely wrote. “Inflation this high may be tolerable for a month or two. … However, inflation pressures probably won’t go unaddressed should they persist.”

The central bank’s latest economic forecast sees inflation running at around 3 per cent for the next year, only falling to the 2-per-cent target by the middle of 2025.

Ms. Freeland’s choice to weigh in on the Bank of Canada’s announcement drew criticism from several economists. In her statement on Wednesday, she said she would “use all the tools at [her] disposal … to ensure that interest rates can come down as soon as possible.” Although, she also said she “fully respects” the central bank’s independence.

The principle of central bank independence holds that the federal government sets the Bank of Canada’s mandate and inflation target every five years, but avoids getting involved in day-to-day monetary policy decision-making.

Derek Holt, Bank of Nova Scotia’s head of capital market economics, called Ms. Freeland’s comments “unhelpful and with rare precedence.”

“I have confidence that the BoC’s Governing Council will do what’s necessary, but the optics – especially before an international audience that funds much of Canada’s open capital markets and that is on heightened alert toward global political interference in central banks – create the impression that political interference risks influencing the BoC’s decisions,” Mr. Holt wrote in a note to clients.

Former Bank of Canada deputy governor Lawrence Schembri said that higher interest rates impose a cost on Canadian borrowers, particularly homeowners and individuals trying to get into the housing market. “However, the bank’s policy interest rate is its primary tool for affecting aggregate demand and ultimately inflation,” said Mr. Schembri, who is now a senior fellow at the Fraser Institute.

“Politicians want to be seen as addressing this concern on the part of these borrowers. They do this even though they know: One, that the bank’s primary mandate is low and stable inflation, as given by its 2-per-cent inflation target, and two, the bank has the operational independence to achieve this objective.”

Mr. Macklem will explain the rate decision in a speech and news conference in Calgary on Thursday. The bank’s next rate announcement is on Oct. 25.

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