When it comes to interpreting the most significant messages in Bank of Canada interest-rate announcements, the bottom line, is, appropriately, found at the bottom.
The last paragraph of the statement that accompanies each rate decision is where the bank tells us where it stands on rate policy, indicates where it might go next, and covers the most important factors that might make, shake or break that position. Skilled observers scour this paragraph for subtle changes from previous statements – a new phrase here, a changed word there – for signals that the bank’s “policy stance” or “bias,” as it’s known, has begun to change.
Wednesday’s concluding paragraph underwent a major rewrite.
That’s not something the bank does lightly, often or by accident. In a decision in which the bank’s policy rate didn’t change at all, the recasting of this critical message suggests significant changes in the bank’s thinking. The Bank of Canada just signalled a turning point in rate policy.
It’s not a massive turn, granted. There’s nothing there that suggests rate cuts are on the horizon. But after a year and a half of increases, the bank made a point of changing its tune, even if it’s still playing some familiar notes.
Here’s how the bank concluded its previous statement, on Sept. 6:
“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 and continue to normalize the bank’s balance sheet. However, Governing Council remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed. Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2-per-cent inflation target. The bank remains resolute in its commitment to restoring price stability for Canadians.”
Here is Wednesday’s rewrite:
“With clearer signs that monetary policy is moderating spending and relieving price pressures, Governing Council decided to hold the policy rate at 5 per cent and to continue to normalize the bank’s balance sheet. However, Governing Council is concerned that progress toward price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed. Governing Council wants to see downward momentum in core inflation, and continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The bank remains resolute in its commitment to restoring price stability for Canadians.”
To the uninitiated, the changes may look trivial. I can assure you, they’re not.
The new emphasis signals that the bank is much more confident that its high interest rates are achieving their purpose. Its concerns have moved away from fears that its rate policy isn’t working – i.e. that inflation pressures haven’t been broken – and toward a worry that progress is too slow. Previously, the bank had pondered whether it would need still higher rates to sufficiently cool the economy, or whether it simply needed to wait longer. Now, it appears that “wait longer” is winning the day.
In this scenario, further rate hikes are unlikely. They’re not off the table, as the bank makes clear. But they have become more remote.
What opened the door for this change was the economy’s surprising loss of momentum in the past few months. The Bank of Canada revised its growth outlook sharply downward from its previous forecast in July; it attributed the slowdown to its past interest-rate increases finally digging in and slamming the brakes on demand.
Crucially, the bank estimated that the output gap – the difference between overall demand and supply capacity – is now either closed, or very close to it. In fact, Tiff Macklem, the head of the bank, said in a news conference after the rate announcement that the economy might already be in “slight excess supply.” That’s huge: Excess demand has been the central worry throughout the bank’s campaign of rate hikes that began in March, 2022. This itself marks a crucial turning point in the bank’s inflation fight.
But there’s a notable asterisk that the bank has left in there: “Inflationary risks have increased.”
That’s a reference to the other key revision in the bank’s forecasts: It raised its inflation projections for this year and next. Inflation in the past few months has run hotter than the bank had expected back in July. The risk, when inflation is running somewhere between 3 per cent and 4 per cent – rather than between 2 per cent and 3 per cent, as the bank had hoped – is that any upside price shocks could send the inflation rate too far above the bank’s comfort zone for it to ignore, even if underlying inflation pressures are easing.
Until the inflation rate retreats to something below 3 per cent – probably not until the second half of next year, the bank now figures – that risk will remain, and the bank might have to keep another rate hike or two in its back pocket. Even if we’ve turned a corner, the bank can’t allow inflation to creep up on us again.