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Bank of Canada hold interest rates in January
Photographer: David Kawai/Bloomberg via Getty Images

Bank of Canada Sets the Stage for a March Rate Hike

The Bank of Canada surprised markets somewhat today by leaving its key lending rate unchanged. It did, however, send a clear signal that rate hikes are imminent.

Leading up to today’s decision, markets had increasingly anticipated that the Bank would deliver a 25-bps rate hike as a first step to addressing high inflation.

Despite raising its inflation forecast for 2022 up to 4.2% (from 3.5% previously), the Bank said in its statement that it expects inflation to decline “reasonably quickly” to around 3% by the end of the year as supply shortages diminish.

“Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target,” the statement read. “The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation.”

The Bank also set the stage for imminent rate hikes with this line: “The Governing Council judges that overall slack in the economy is absorbed…[and has] decided to end its extraordinary commitment to hold its policy rate at the effective lower bound.”

“The Bank sent as loud a warning shot that rates are going up at the next meeting as they possibly could (without an explicit pledge),” wrote BMO chief economist Douglas Porter.

While speaking to reporters, Governor Tiff Macklem followed that up by committing to bring inflation back to target (currently around 2.25%) and that Canadians can expect higher rates in a “series of steps.”

Meanwhile, a similar story played out south of the border where the Federal Reserve also opted to leave rates unchanged, but signalled a forthcoming rate hike in March.

Reaction to the Bank’s paced approach

Following the decision, bond markets immediately raised expectations for a March rate hike to about 90%, with five hikes now priced in for the year. That would bring the overnight target rate to 1.50%, up from its current 0.25%, where it’s been ever since March 2020.

Delaying its first rate hike earned the Bank some critics, who argued a move today was needed to better address high inflation.

It “remains apparent that the central bank has retained an ongoing run-hot bias toward inflation and house prices, as it is far behind the appropriate stance of monetary policy for this point in the cycle,” wrote Scotiabank economist Derek Holt.

“They should have hiked rates today. There’s no reason to have record-low rates in Canada right now. Period,” said rate analyst Rob McLister in an interview with BNN Bloomberg.

With inflation at a three-decade high, inflation expectations ramping up and a potential wage spiral “of some degree” kicking in, McLister argued the Bank risks falling behind on controlling inflation.

“A lot of economists will tell you that the Bank of Canada is potentially behind the curve on hiking rates,” he added. “And when you get behind the curve on hiking rates, it takes more increases and/or faster increases to bring inflation back near the 2% target.”

The Bank of Canada’s Latest Forecasts

Here are the key takeaways from the Bank’s latest Monetary Policy Report (MPR):

Inflation

  • The bank expects consumer price index (CPI) inflation to average:
    • 4.2% in 2022 (vs. 3.4% in its previous forecast)
      • The Bank expects inflation to peak above 5% this quarter
    • 2.3% in 2023 (unchanged)

GDP forecast

  • The Bank now expects annual economic growth of:
    • 4% in 2022 (from 4.3%)
    • 3.5% in 2023 (from 3.7%)

Article feature image: Photographer: David Kawai/Bloomberg via Getty Images