"The Bank of Canada's Balancing Act: Inflation, Interest Rates, and the Economy"

As I sit here, sipping my afternoon coffee, I can't help but reflect on the latest move by the Bank of Canada. They've bumped up the benchmark rate to a 22-year high of 5%, a 0.25% increase from June. This latest round of rate increase means prime rate is expected to rise to 7.2%.

The reason? A mounting pile of evidence pointing to persistent excess demand and elevated core inflation. This move didn't exactly come as a surprise, but it's still a bit unsettling, especially with the Bank's commitment to continue its policy of quantitative tightening.
Let's dive a bit deeper into the Bank's current stance on inflation, interest rates, and the economy, shall we?

The Inflation Story

In May, Canada's Consumer Price Index (CPI) inflation cooled down to 3.4%, a significant drop from the 8.1% peak last summer. This decrease was largely due to lower energy prices, rather than a reduction in underlying inflation. 

With the large price increases of last year no longer affecting the annual data, we can expect less downward momentum in CPI inflation in the near future.

Interestingly, core inflation has been hovering around 3.5% to 4% since last September. This suggests that underlying price pressures are sticking around longer than expected. 

Businesses are still raising their prices more frequently than usual, which reinforces this outcome. 

On a global scale, inflation is easing due to lower energy prices and a decline in goods price inflation. However, robust demand and tight labour markets are causing persistent inflationary pressures in services.

Canada's Economic Performance

Canada's economy has been flexing its muscles, showing more momentum in demand than anticipated. Consumption growth was surprisingly strong at 5.8% in the first quarter. 

While we expected consumer spending to slow due to the cumulative increase in interest rates, recent data suggests that excess demand in the economy is more persistent.

The housing market has also seen some action. New construction and real estate listings are trailing behind demand, which is pushing up prices. In the labour market, there are signs of more worker availability, but conditions remain tight, and wage growth has been around 4-5%.

Strong population growth from immigration is adding both demand and supply to the economy. Newcomers are helping to ease the shortage of workers while also boosting consumer spending and adding to demand for housing.

Global Economic Performance
Economic growth has been stronger than expected, especially in the United States, where consumer and business spending has been surprisingly resilient. After a surge in early 2023, China's economic growth is softening, with slowing exports and ongoing weakness in its property sector. 

Growth in the euro area is effectively stalled: while the service sector continues to grow, manufacturing is contracting.

Global financial conditions have tightened, with bond yields up in North America and Europe as major central banks signal further interest rate increases may be needed to combat inflation.

Looking Ahead

As higher interest rates continue to permeate the economy, the Bank of Canada expects economic growth to slow, averaging around 1% through the second half of 2023 and the first half of next year. 

This implies real GDP growth of 1.8% in 2023 and 1.2% in 2024. The Canadian economy will then move into modest excess supply early next year before growth picks up to 2.4% in 2025.

In its July Monetary Policy Report, the Bank noted that CPI inflation is forecast to hover around 3% for the next year before gradually declining to 2% in the middle of 2025. This is a slower return to target than was forecast in its January and April projections. 

As a result, the Bank's Governing Council remains concerned that progress towards its 2% inflation target could stall, jeopardizing the return to price stability.

In terms of what we can expect in the near term, the Bank had this to say: "Quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the Bank’s balance sheet. 

We will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the 2% inflation target. 

We remain resolute in our commitment to restoring price stability."

So, mark September 6th, 2023 on your calendar. That's the date of the Bank's next scheduled policy rate announcement. I'll be right here, ready to break down that decision for you.