The Bank of Canada left monetary policy unchanged Wednesday in a stand-pat interest-rate decision that highlighted stubbornly high inflation and accelerating wage growth while pointing to economic uncertainty tied to the Omicron variant of COVID-19.
The central bank kept its overnight rate at 0.25 per cent, saying the Canadian economy continues to require considerable monetary policy support. It also reiterated its timeline for potential rate hikes, saying that the conditions to begin raising rates will likely be met in the middle quarters of next year.
The bank is on the cusp of a period of sustained rate increases, with analysts widely predicting it will start increasing rates next April, and financial markets pricing in as many as five rate hikes next year. The bank has run an ultrastimulative monetary policy during the pandemic, but is now having to tighten up policy faster than previously expected in the face of persistently high inflation.
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The annual inflation rate has been above the bank’s target range of 1 per cent to 3 per cent since this past April, hitting an 18-year high of 4.7 per cent in October. The bank said it expects inflation to “remain elevated” in the first half of next year, before easing back toward 2 per cent in the second half.
“Inflation is elevated and the impact of global supply constraints is feeding through to a broader range of goods prices. The effects of these constraints on prices will likely take some time to work their way through, given existing supply backlogs,” policy makers said in the rate decision statement.
At the last rate meeting in October, the bank’s governing council opted to end the bond-buying program, also known as quantitative easing, that had seen the bank buy hundreds of billions worth of government bonds during the pandemic in an attempt to hold down interest rates.
The statement-only decision on Wednesday, by contrast, was largely a placeholder. Any potential changes to the bank’s outlook for rate hikes have been pushed to its next rate decision in January, when the bank will publish a new economic forecast.
Yields on short-term bonds fell slightly after the announcement, suggesting investors were expecting the bank to adopt a more aggressive tone, Royal Bank of Canada senior economist Josh Nye said in a research note.
“The BoC was held back by Omicron uncertainty but today’s statement suggests that as long as that risk doesn’t intensify in the next seven weeks, the BoC will sound more hawkish in January,” Mr. Nye said.
The strength and persistence of the current bout of inflation has caught central banks around the world by surprise, forcing them to adjust their narrative about inflation and to speed up their pace of monetary policy tightening. The Bank of Canada was ahead of many of its peers in winding down quantitative easing in October. It is now in what it calls the “reinvestment phase,” in which it is maintaining the size of its balance sheet, but no longer increasing it.
Last week, U.S. Federal Reserve chair Jerome Powell said it was time to retire the word “transitory” when talking about high inflation, and suggested it would be appropriate to accelerate the end of the Fed’s quantitative easing program, which was previously expected to continue until next summer.
Pressure on the Bank of Canada to raise rates has increased in recent weeks after an exceptionally strong jobs report and growing signs that wage growth is picking up pace. Statistics Canada reported last week that Canada added 157,300 jobs in November. The unemployment rate dropped to 6 per cent from 6.7 per cent.
The bank said that the employment rate is “essentially back to its pre-pandemic level” and noted that “job vacancies remain elevated and wage growth has also picked up.”
To date, policy makers have maintained that wage growth isn’t feeding into general inflation pressures. But the bank said Wednesday it “is closely watching inflation expectations and labour costs to ensure that the forces pushing up prices do not become embedded in ongoing inflation.”
Positive labour-market developments are particularly important at the moment, as the bank has made interest-rate hikes conditional on employment recovering from the pandemic in a broad-based manner, and hard-hit workers returning to the labour force. The Wednesday rate decision reiterated that the bank will hold its policy rate close to zero “until economic slack is absorbed.”
The rate decision painted a mostly optimistic picture of the economy, saying there was “considerable momentum” heading into the fourth quarter. But it did sound a note of caution.
“The devastating floods in British Columbia and uncertainties arising from the Omicron variant could weigh on growth by compounding supply chain disruptions and reducing demand for some services,” the bank said.
Desjardins chief economist Jimmy Jean said in a research note that the bank is on course to start raising rates in April, although it does not appear to be in a rush.
“While the BoC remains attuned to the inflationary risks, and has not employed the ‘transitory’ vocabulary in this statement, the sense we get is that it is not in panicky mode either, and will take its time to make sense of the current shocks affecting the global outlook,” he said.
Bank of Canada deputy governor Toni Gravelle will give additional details about the bank’s economic outlook in a speech and news conference on Thursday.
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