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opinion

The Bank of Canada building in Ottawa.Sean Kilpatrick/The Canadian Press

In finally launching a cycle of interest rate increases, the Bank of Canada all but admitted that the move was overdue. But with the war in Ukraine pulling monetary policy in opposite directions, there’s still a hint of hesitation in the central bank’s words.

The quarter-percentage-point rate hike that the bank announced Wednesday was both well-telegraphed and widely anticipated, but it was, nevertheless, a pretty momentous occasion. The last time it raised rates, in October, 2018, neither Bank of Canada Governor Tiff Macklem nor senior deputy Carolyn Rogers were even employed by the bank. Inflation was 2.4 per cent, a bit hotter than the bank’s 2-per-cent target. The bank had never heard of COVID-19, and had never had to slash its key rate to near zero to defend the economy against a global health and economic crisis.

Today, Mr. Macklem and Ms. Rogers face inflation of 5.1 per cent, a three-decade high – and it’s likely headed higher before it turns lower. The Canadian economy has fully recovered from the COVID-19 recession much faster than the bank had anticipated. The combination has made rate hikes both inevitable and essential – not just the single increase announced Wednesday, but, in all likelihood, a series of increases over the next year or more.

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And, frankly, it looks as if the Bank of Canada arrived late to its own party.

Earlier this week, Statistics Canada reported that real gross domestic product surged at a 6.7-per-cent annualized pace in the fourth quarter of 2021, well ahead of the bank’s estimate. The figures showed that the economy had fully recovered its pandemic losses as of roughly three months ago. Preliminary January data indicate that the economy continued to grow even as the Omicron variant of the COVID-19 virus forced a new round of shutdowns and restrictions.

In the bank’s statement accompanying the rate decision, it acknowledged that the stronger-than-expected growth “confirms its view that economic slack has been absorbed.”

The bank began hinting in mid-December that there was little if any slack remaining in the economy. It stated flat-out in its January rate decision that “a broad set of measures are now indicating that economic slack is absorbed.” Its statement Wednesday – that the GDP data confirm what the bank had already concluded five weeks ago – is about as close as you may ever see to a central bank acknowledging that it has gotten itself a little behind the curve on starting to raise rates.

And yet there remains some hesitance in Wednesday’s decision. Russia’s invasion of Ukraine has thrown a whole set of new and fast-changing variables into the mix.

The conflict already looks like the driver of still more inflation: Uncertainty over the security of oil and natural gas supplies from Russia have sent crude prices skyrocketing more than 20 per cent since last Friday. On the other hand, if supply interruptions and shortages were to occur in Europe, the implication is certainly negative for output, business confidence, consumption and investment – it would be a major drag on global growth.

And yet, higher oil and gas prices are a boon for Canada’s energy sector, generating increased income and, perhaps, creating a powerful impetus for new investment in the sector. The surging energy prices also improve the country’s terms of trade – which would be supportive of a stronger dollar, offsetting at least some of those inflation pressures by easing the cost of imports.

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Obviously, a serious escalation of the conflict would be overwhelmingly negative for the global economic outlook, in addition to being a human tragedy. That would put central banks, here and elsewhere, in a very different place than they were a week ago.

The fact that the Bank of Canada went ahead with its rate hike is an indication that its thinking hasn’t strayed too far toward such bad-case scenarios. Nevertheless, at this still-early stage of the invasion, the uncertainty surrounding all of this may have been enough for it to pull its policy punch.

This was most noticeable in its decision to hold the line on the other pillar of its pandemic policy: its quantitative easing program, under which it has purchased hundreds of billions of dollars in government bonds over the past two years. The bank had been hinting that it might start reducing those bond holdings in conjunction with the beginning of rate hikes, but Wednesday’s announcement indicated that the bank is still just thinking about it, with no update on the potential timeline. Given the actions taken by Western allies to freeze Russian assets, cut off its central bank and block its access to global payment systems, this may have seemed like an inopportune time to alter the Bank of Canada’s terms of engagement in a key segment of the bond market.

We’ll get a clearer sense Thursday of just how much the uncertainty has weighed on the bank’s thinking, when Mr. Macklem provides the bank’s post-decision economic update speech, followed by a news conference and an appearance before the House of Commons finance committee. But it’s certain the Ukraine crisis has put a new set a variables in the bank’s interest rate path. Whether it alters the course will be a burning question as the situation evolves.

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