Bank of Canada deputy signals end is near on rate hikes, as central bank becomes ‘data dependent’

The Bank of Canada could pause interest rate hikes as early as next month as it shifts to a more “data-dependent” approach to monetary policy, although the bank is still prepared to be “forceful” if necessary, deputy governor Sharon Kozicki said on Thursday.

“We are moving from how much to raise interest rates to whether to raise interest rates,” Ms. Kozicki said in a speech to the Urban Development Institute of Quebec in Montreal.

She was speaking the day after the bank delivered another 50-basis-point rate hike, lifting the benchmark lending rate to 4.25 per cent, the highest level since early 2008.

After seven consecutive rate hikes, which have dramatically increased the cost of borrowing for Canadians over the past nine months, the bank is preparing to step back to assess the impact of its aggressive tightening on inflation and the broader economy.

Interest rate increases typically take up to six to eight quarters to have a full impact on spending and inflation. This lag means the Bank of Canada can’t immediately measure the effects of its rate hikes, which creates the risk that it will increase borrowing costs more than is necessary to bring inflation under control.

“If we are surprised on the upside, we are still prepared to be forceful. But we recognize that we have raised interest rates rapidly and that their effects are working their way through the economy,” said Ms. Kozicki, who is a member of the central bank’s five-person governing council.

The next rate decision on Jan. 25 will be based on incoming data, she said. Financial markets expect the bank to stand pat at 4.25 per cent next month.

Inflation has trended down since the summer, although recent inflation data have presented “a mixed picture,” Ms. Kozicki said. The annual rate of consumer price index inflation stood at 6.9 per cent in October, down from a peak of 8.1 per cent in June. The bank targets 2-per-cent annual inflation.

“On one hand, inflation remains too high, with many of the goods and services Canadians regularly buy showing large price increases. On the other hand, three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum,” she said.

She noted several areas where price pressures remain stubbornly high, including at the grocery store, where prices have continued to increase even as agricultural commodity prices have fallen in recent months.

Higher interest rates curb inflation by making it more expensive for people to borrow money and to service their debt. This reduces spending throughout the economy, acting as brake on price increases. In other words, the central bank is intentionally slowing the economy in the hope of restoring price stability.

So far the Canadian economy has proven fairly resilient. GDP grew nearly twice as much as the bank expected in the third quarter and the unemployment rate is near record low. The economy continues to operate with “excess demand,” Ms. Kozicki said, which can be seen in elevated job vacancies and rapidly rising wages.

There are, however, clear signs that higher interest rates are starting to bite. This is most evident in the housing market, where sales volumes have plummeted and prices have slumped.

Rate hikes also seem to be bleeding through to broader consumer spending, particularly on durable goods, such as automobiles and furniture. Household spending fell 0.3 per cent in the third quarter, the first drop since the second quarter of 2021.

Sectors that rely on borrowed money, such as real estate and car sales, tend to get hit first by rate hikes. Other industries are squeezed over time as people have to spend more money servicing their debt and have less to spend on other goods and services.

“The economy is still too hot for the central bank to rest easy,” Royce Mendes, head of macro strategy at Desjardins, wrote in a note to clients about the speech. That said, “in the near-term the data won’t have to turn all that much for the central bank to hit the pause button, given that it typically takes many quarters to feel the full impact of monetary actions,” he added.

The central bank is expecting the economy to weaken in the coming months. It is forecasting near-zero growth over the next three quarters, and has said there is a roughly 50-50 chance that the Canadian economy experiences several quarters of negative growth – one common definition of a recession.

Central bank officials have said that unemployment needs to rise to get inflation under control, although they are not expecting a major uptick in joblessness as in previous recessions.

“We know this is a very challenging time for Canadians. Increased borrowing costs in the near term will deliver the benefits of low inflation, but only with a delay,” she said.