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Tiff Macklem, Governor of the Bank of Canada, holds a news conference at the Bank of Canada in Ottawa on Jan. 25.Sean Kilpatrick/The Canadian Press

The Bank of Canada increased interest rates again on Wednesday but said that it expects to hold off on further rate hikes, making it the first major central bank to signal an end to monetary policy tightening.

The bank raised its benchmark rate by a quarter of a percentage point, bringing the policy rate to 4.5 per cent, the highest level since 2007. This was the eighth consecutive rate hike in 11 months.

“We have raised rates rapidly, and now it’s time to pause and assess whether monetary policy is sufficiently restrictive to bring inflation back to the 2-per-cent target,” Bank of Canada Governor Tiff Macklem said in a news conference after the rate announcement.

“To be clear, this is a conditional pause,” Mr. Macklem added. “If we need to do more to get inflation to the 2-per-cent target, we will.”

The bank lowered its forecast for inflation on Wednesday. It also reiterated that it expects the economy to “stall” in the first half of the year, but does not foresee a significant recession.

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The bank’s decision to announce a “conditional pause” marks a major shift in monetary policy. Over the past year, it has forced Canadian borrowing costs sharply higher to combat runaway inflation. This has hammered the housing market and pushed the economy to the edge of a recession.

Now with price pressures easing and the economy starting to stall, central bank officials believe that interest rates are likely as high as they need to go. That puts the Bank of Canada ahead of its peers in halting its aggressive inflation-fighting campaign, launched last year as consumer prices surged at the fastest pace since the 1980s.

The bank now expects consumer price index inflation to fall to about 3 per cent by the middle of this year, and to 2.6 per cent by the fourth quarter. It sees inflation returning to the 2-per-cent target in 2024.

The annual rate of inflation remains well above those levels, clocking at 6.3 per cent in December. But it has trended down from a peak of 8.1 per cent in June. Price pressures continue to ease thanks to a drop in oil prices and improvements in global supply chains, plus the slowing effects on the economy of the bank’s rate increases.

The expected drop in inflation comes alongside a slowdown in the Canadian economy. The bank expects growth to flatline through the first half of 2023, as higher borrowing costs squeeze Canadians’ finances and weigh on consumer spending and business investment.

“It’s just as likely that we’ll have two or three quarters of slightly negative growth as slightly positive growth,” Mr. Macklem said. “So yes, it could be a mild recession. It’s not a major contraction.”

So far, the Canadian economy has proven remarkably resilient in the face of higher interest rates. Unemployment is near a record low and GDP growth was stronger than expected in the fourth quarter of 2022. The Bank of Canada says that the economy remains in a state of “excess demand.”

But higher interest rates are starting to have an impact beyond the housing market. Consumers are cutting back on big-ticket purchases. The bank expects spending to slow further as homeowners renew their mortgages at higher interest rates and nervous shoppers cut out non-essential items.

“The rise in borrowing costs is expected to continue to strain many household budgets. Interest payments on household mortgages are estimated to be about 4.5 per cent of disposable income at the beginning of 2023, up from 3.2 per cent at the beginning of 2022,” the bank said in its quarterly Monetary Policy Report (MPR), published Wednesday.

“The share of income going to mortgage interest payments is anticipated to continue rising.”

The prospect of a recession, even a mild one, raises questions about when the Bank of Canada might start cutting interest rates. Financial markets are pricing in at least half-a-percentage-point rate cut by the end of the year.

Mr. Macklem said that it was far too early to be talking about interest-rate cuts. As for further rate increases, the bank would need to see an “accumulation” of evidence that inflation and economic growth was overshooting the bank’s forecast before hiking again, he said.

Ian Pollick, head of fixed income, currency and commodities strategy at Canadian Imperial Bank of Commerce, said that the Bank of Canada may be painting itself into a corner by being so vocal about halting rate hikes.

“If you do have a situation where you have more stickiness in service inflation, or you have an unexpected acceleration of growth above what they had expected, then the messaging becomes more difficult,” Mr. Pollick said.

“One of the things that we learned, particularly after we found out that Australian CPI has re-accelerated, is that it’s a very uncertain environment.”

The bank highlighted several risks to its inflation outlook in its monetary policy report. Service price inflation could prove more persistent than expected. Oil prices could also rise more than anticipated, depending on what happens with the war in Ukraine and China’s reopening from COVID-19 lockdowns.

The ultratight labour market remains a challenge for the central bank. Low unemployment and high demand for workers is fuelling wage growth. That’s good for workers. But rising labour costs are feeding through into inflation, particularly in the service sector.

Mr. Macklem argues that unemployment needs to rise and job vacancies need to decline to get inflation back to target.

“The risk of a wage-price spiral has gone down. But … wages running in the 4 to 5 per cent range, if that were to persist, if that was to be sustained, unless there’s a surprisingly strong acceleration in productivity, that’s not consistent with getting inflation back to our 2-per-cent target,” he said.

Wednesday’s announcement was largely good news for the housing market, said Christopher Alexander, president of Re/Max Canada. The quarter-point rate hike has increased variable rate mortgages yet again. But the prospect of a pause in rate hikes removes some of the uncertainty that was keeping people on the sidelines of the real estate market, he said.

“I think that this signal is going to give buyers and sellers confidence now to come back to the market. And that’s been really the story of this inflationary period, it’s been a bit of a standoff between new listings and people who are willing to transact,” he said.

The central bank, for its part, predicts that home prices still have further to fall in the coming quarters. It expects a rebound in real estate activity later in the year.

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