Bank of Canada keeps key rate at 5%, says talks have shifted away from more hikes

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The Bank of Canada held its policy interest rate steady for the fourth consecutive time on Wednesday, but dialled back its threat of further rate hikes in a notable shift in language that opens the door to possible rate cuts in the first half of this year.

The widely expected decision kept the bank’s benchmark interest rate at 5 per cent, a two-decade high reached last July.

While the bank remained on hold, it said that Canada’s sluggish economy has now entered a state of “excess supply,” which should help drag inflation down over time. And it effectively confirmed what financial markets have assumed for months: that interest rates have peaked for this business cycle.

“With overall demand in the economy no longer running ahead of supply, Governing Council’s discussion of monetary policy is shifting from whether our policy rate is restrictive enough to restore price stability, to how long it needs to stay at the current level,” Bank of Canada Governor Tiff Macklem said at a news conference after the rate announcement.

He did not rule out further rate hikes altogether, but suggested they were unlikely if inflation and economic activity developed in line with the bank’s projection.

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With economic growth stalling in Canada and inflation hovering near the upper end of the central bank’s 1-per-cent to 3-per-cent control range, Bay Street analysts and investors expect the bank to start cutting interest rates in the coming quarters. Most are betting the first quarter-point cut will happen in April or June.

Mr. Macklem refused to put a timeline on rate cuts, batting away questions during the news conference. “I think it’s important that we don’t give Canadians a false sense of precision,” he said. “We’re going to have to see how inflation evolves.”

Inflation has come down a long way over the past 1½ years. After hitting a peak of 8.1 per cent in mid-2022, annual Consumer Price Index inflation dropped to as low as 2.8 per cent last June, before finishing the year at 3.4 per cent. The bank targets 2-per-cent inflation.

Despite broad-based progress, however, Mr. Macklem and his team remain concerned about “underlying” price pressures, as well as pockets of high inflation, notably fast-rising shelter and food prices.

Core measures of inflation, which strip out the most volatile components of the CPI, have been stuck in the 3.5-per-cent to 4-per-cent range for the better part of a year. Mr. Macklem said the bank needs to see “further and sustained easing of core inflation” before considering rate cuts.

Avery Shenfeld, chief economist at Canadian Imperial Bank of Commerce, said in a note to clients that the change in the central bank’s language around rate hikes amounted to a “dovish tilt.”

“Canadians will have to live through some economic disappointments in upcoming quarters, with the Bank not in a hurry to trigger an upsurge in growth until it gets a bit more comfortable with the underlying pace of inflation,” Mr. Shenfeld wrote.

“But its projections for better growth later this year, as well as the shift in its deliberations toward a focus on how long they need to keep rates at this level, are clear signs that its own outlook includes some meaningful interest rate cuts taking hold in the back half of the year.”

Between March, 2022, and last July, the bank raised interest rates 10 times to try to halt runaway inflation. Higher interest rates make it more expensive for individuals and companies to borrow money and service debts, with the goal of dampening economic activity and reducing upward pressure on prices.

How economists and market bets for future rate cuts are reacting to today’s BoC decision

This tight monetary policy is having its intended impact. Economic growth in Canada has effectively stalled since the middle of 2023 and unemployment is on the rise.

So far the economy has avoided an outright recession, which many economists were predicting this time last year. However, growth is anemic and it would not take much to push the economy into a contraction. In its quarterly Monetary Policy Report (MPR), published Wednesday, the bank forecasts just 0.8-per-cent GDP growth in 2024. It sees this picking up to a more robust 2.4 per cent in 2025.

Weak economic activity should continue to weigh on inflation. The bank sees inflation staying around 3 per cent for the first half of the year, before falling to 2.5 per cent by year-end, and back to the 2-per-cent target in 2025.

But progress could be “gradual and uneven,” Mr. Macklem warned.

Shelter inflation remains a particular concern. Mortgage interest costs have spiked – a product of the bank’s past interest-rate hikes – while rents continue to rise quickly. House prices have also fallen less than the central bank expected, given the sharp jump in borrowing costs over the past two years.

“Persistent structural supply challenges and strong underlying demand from population growth will likely continue to put pressure on house and rental prices,” the bank said in its MPR.

Derek Holt, head of capital markets economics at Bank of Nova Scotia, said there are a number of other factors that could put upward pressure on inflation and prevent the central bank from easing monetary policy in the coming months. These include rapid wage increases, government deficits, and potential supply chain disruptions tied to the conflict in the Middle East.

“I think they’re waiting for evidence on the federal and provincial budget season, mortgage pre-approvals into the spring housing market, and further evidence on core inflation,” Mr. Holt said in an interview. “The April meeting will be the more meaningful one. But for now, it was just buying time.”

The housing market is a crucial variable. After the central bank announced a “conditional pause” on rate hikes last year, there was a burst of real estate activity and a run-up in home prices. This was one of the factors that led the Bank of Canada to deliver two additional rate hikes last summer, in June and July.

Phil Soper, chief executive of real estate companies Royal LePage and Bridgemarq Real Estate Services, said he expects the housing market to pick up steam this spring as buyers adjust to the idea that interest rates are likely not moving higher.

First-time buyers, in particular, have been sitting on the sidelines because they think further monetary-policy tightening could push home prices lower, Mr. Soper said. With the central bank now effectively calling the top on interest rates, that could pull these buyers into the market, to try to get in before prices start to rebound, he said.

Mr. Soper said he doesn’t expect the bank to cut rates until June or later. “But we don’t think that’s necessary for there to be a shift in the market … both in terms of, first, activity and, second, modest uptick in prices.”