The Bank of Canada is expected to keep interest rates on hold this week and remain mum on the timing of future rate cuts, even as the pace of inflation has retreated to within the central bank’s target range.
Bay Street analysts expect the bank to keep rates unchanged at 5% on Wednesday, the fifth consecutive rate announcement. The bank raised its borrowing costs tenfold in 2022 and the first half of 2023, but has been holding off on funding since July, waiting for inflation to return to normal amid weak economic activity.
Governor Tiff Macklem said in his last announcement in January that further rate hikes were unlikely at this time, a significant change after months of hinting at further rate hikes.
However, he declined to say when he would cut interest rates, saying he would not consider monetary easing until core inflation measures, which remove volatile price fluctuations, showed “clear downward momentum.”
Consumer price index inflation has declined significantly over the past 18 months. But minutes from the January meeting show central bank officials remain concerned that they cut rates too soon and will have to change course. They also want to avoid adding fuel to the spring real estate market, which is already seeing strong home sales as buyers re-enter the market in hopes of lower interest rates this year.
“While data has been mixed since January’s policy announcement, with growth slightly better than expected, the latest CPI report was the most encouraging in years,” Bank of Bank Canada Interest Rates said.・Benjamin Reitzes, Managing Director of Macro Strategy, said: Montreal wrote in a note to customers.
“These reports are not enough to change the central bank’s policy. The central bank has been preaching patience as policymakers wait for inflation to approach the 2% target before considering easing.”
Analysts expect the central bank to remain cautious in its announcements this week, but recent data have generally been better than bankers and private sector observers had expected.
In January, the annual rate of CPI inflation fell to 2.9%, passing a key threshold back to the bank’s target range of 1% to 3%. This is a far cry from the 8.1% inflation rate achieved in mid-2022, and marks the second time since spring 2021 that inflation has fallen below 3%.
Inflation pressures have eased in many sectors, and the central bank’s recommended core inflation rate fell significantly in January. However, there are still areas where prices can rise quickly. Shelter inflation, which takes into account rent, mortgage costs and other housing-related costs, rose 6.2% in January, up from a 6% rise in December.
Canada’s economic growth is sluggish. But the country has so far avoided the recession that many economists predicted this time last year. Real gross domestic product (GDP) increased at an annual rate of 1% in the fourth quarter, supported by exports to the US, where the economy is strong.
This near-zero growth rate is something of a sweet spot for central banks. They are deliberately trying to slow economic activity to reduce upward pressure on prices, but they don’t want to go too far and push the economy into a ditch.
“The Bank of Canada has been benefiting for a while now simply because the bottom hasn’t fallen out of the economy,” James Orlando, senior economist at Toronto-Dominion Bank, said in an interview.
“If the economy is contracting and a recession is expected, the Bank of Canada won’t have time to sit around and wait for inflation to go down. They’ll have to cut right away. Not applicable at this time.”
Most analysts expect the central bank to start cutting rates around mid-year, perhaps at its June meeting. However, some believe the bank could take action as early as April, given recent positive inflation data.
The interest rate swap market, which reflects market expectations about monetary policy, puts the probability of a rate cut in April at just under 40%, according to Refinitiv data. This would rise to nearly 80% if rates were cut by June.
As the bank takes steps towards monetary easing, soaring shelter prices and the soaring real estate market remain key challenges.
Rising mortgage interest costs are directly related to banks’ past interest rate decisions and are the largest contributor to overall inflation. But rate cuts that provide some relief to homeowners with mortgages are likely to push up home prices and further undermine housing affordability.
At the same time, the bank said there was not much that could be done about high rent inflation, which was being caused by a severe mismatch between housing supply and rapid population growth. Some economists have therefore suggested that the central bank should take shelter inflation into account when deciding when to cut interest rates.
“Canada has a housing problem, not inflation, and the central bank’s policies risk exacerbating the situation,” Olivia Cross, North American economist at Capital Economics, said in a note to clients.
“High interest rates are weighing heavily on pre-construction sales that developers rely on to finance their projects,” she wrote. “As a result, housing starts have continued to trend downward in recent months, despite the potential for a boost from unseasonably warm weather. The case for easing policy restrictions is therefore more persuasive. ”
Analysts will be watching Wednesday for any hints about an end to the Bank of Canada’s quantitative tightening (QT) program, in which it shrinks the size of its balance sheet to compensate for high interest rates.
Bank officials said last year that they expected QT to end in late 2024 or early 2025. However, there have been recent signs of stress in the short-term lending market, leading to speculation that the bank may wind down QT in the coming months.
