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Bank of Canada Increases Overnight Rate to 2.5%

Today, the Bank of Canada surprised markets with a 100 basis point (1%) increase in its target overnight lending rate to 2.5%. (Press Release: Bank of Canada increases policy interest rate by 100 basis points, continues quantitative tightening – Bank of Canada).

Markets had been expecting another 0.75% increase based on the bank’s comments in May that it expected the neutral rate (neither stimulative nor restrictive to economic growth) to be about 2.5%, but that it would re-evaluate this target based on inflation and other statistics. Inflation has remained persistent in the face of ongoing supply chain disruptions, Chinese COVID lockdowns, and the war in Ukraine, and job vacancies remain at record highs without sufficient labour force to meet the demand surge after this year’s re-opening.

The Bank of Canada said this week that the neutral rate may need to go to 3-3.5% to balance demand to available supply, and the economy was strong enough to absorb the interest rate increases without causing a recession, so it wanted to ‘front load’ the rate increases to reduce inflation pressures immediately, and avoid even higher targets being needed in the long term. We should therefore expect a further rate increase at the bank’s next meeting September 9th, and at the next US Federal Reserve meeting July 26-27.

While the bank does not believe the higher rates will cause a recession, they do expect economic growth to slow. Still, their expectations are for reasonable growth rates of 3.5% this year, 1.75% in 2023, and 2.5% in 2024. Because inflation measures price changes from past levels, they expect about 8% inflation readings for the balance of the year, but a return to 3% by the end of 2023.

Bond markets had anticipated further rate increases so their yields and prices had already adjusted before the announcement. Top GIC rates are now over 4% for a 1-year term, and top daily interest deposit rates of 1.3% may see an increase in the coming days.

Video summary: Monetary Policy Report – July 2022 – Bank of Canada
Full Report: Monetary Policy Report – July 2022 (bankofcanada.ca)

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Peak Inflation? Annual Rate still high, but monthly rate declines in April.

The US Bureau of Labor Statistics today released Consumer Price Index (CPI) data for the month of April, showing seasonally-adjusted price increase of only 0.3% from March levels. This reaffirms the view of some commentators that inflation should naturally slow from recent record year-over-year rebounds from pandemic-induced price decreases in 2020.

The graph below shows the month-over-month price level change, which has hovered between 0 and 0.5% per month for the past 5-10 years. You can see the negative inflation in 2020 March – May, which took CPI down 1.2% during that period, limiting total annual inflation to only 1.2% for the year. 2021 made up for that as demand for goods surged amid pandemic restrictions on services, and covid-induced supply chain disruption, with a 7% total inflation for the year. Those supply chain disruptions continue into 2022: first quarter 2022 inflation has been just shy of 3%, with 1.2% of that in March alone, with the conflict in Ukraine spiking oil and energy costs, which are feeding through to the price of all goods and services that use them.

(Source: Bureau of Labor Statistics https://www.bls.gov/cpi/latest-numbers.htm )

Some goods prices have started to decline as their supplies become more balanced, used car prices being one example. Historically, oil prices have not stayed much over $100 per barrel for long, and even if they stay at that level, at least they would not contribute directly to further inflation in coming periods. For this reason, some analysts believe we have seen the peak in monthly inflation at 8.5% in March, and that the year-over-year figure, down to 8.3% in April, will continue to moderate as the year continues. This may take some pressure off central banks on the need for interest rate increases.