Today marked the eighth consecutive rate hike by the Bank of Canada, and the first of 2023. If market expectations are correct, it could also be its last of this rate-hike cycle.

As expected, the BoC raised rates by 25 basis points, bringing its overnight target rate to 4.50%—425 bps higher than where it was last March.

In its statement, the Bank pointed to ongoing tight labour market conditions and “persistent excess demand” as reasons for the rate hike, but also clearly indicated it’s preparing for a pause.

“…if economic developments evolve broadly in line with the [Bank’s] outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases.”

Benjamin Reitzes of BMO Economics said the statement was more dovish than expected, which caused Government of Canada bond yields (which lead fixed mortgage rates) to rise.

“While policymakers haven’t shut the door on more hikes, the bar for further tightening is quite high,” he commented.

Where to from here?

While the Bank reiterated that it is “prepared to increase the policy rate further,” most observers believe that will be unnecessary in the face of weaker economic conditions moving forward.

“The lagged impact of the aggressive interest rate increases in 2022 is expected to slow consumer spending and business investment in the year ahead,” noted Nathan Janzen,
Assistant Chief Economist at RBC Economics. “The household debt-service ratio will likely hit record levels this year, in large part as households renew mortgages at higher interest rates.”

Economists at ING have also flagged rising debt levels as a reason the Bank is likely to make this rate hike its last.

“Given Canada’s high household debt exposure and greater vulnerability to rising interest rates via the mortgage market structure, we think the economy and inflation could slow more rapidly than the BoC is currently projecting,” they wrote. “Consequently, we think the next move will in fact be an interest rate cut with the potential first easing coming as soon as late in the third quarter.”

Economists at National Bank of Canada agree that the next rate move is likely to be a cut.

“In our view, interest rates will not need to be kept at current levels for very long to brake inflation,” they wrote. “Accordingly, expect the Bank to be obliged to lower them in the second half of [2023].”

The BoC’s latest forecasts

As part of today’s announcement, the Bank of Canada also released its latest Monetary Policy Report (MPR). Here are the highlights of its updated forecasts:

Inflation

• The bank expects consumer price index (CPI) inflation to average:
  • 3.6% in 2023 (vs. 4.1% in its previous forecast)
  
  
  • 2.3% in 2024 (vs. 2.2%)

“CPI inflation in Canada is still too high but has declined from its recent peak,” the report reads. The forecast for 2023 has been lowered “mainly due to gasoline prices dropping more than expected and global supply chains improving more quickly than anticipated.”

GDP forecast

• The Bank now expects annual economic growth of:
  • 1% in 2023 (from a previous forecast of 0.9%)
  • 1.8% in 2024 (from 2%)

The BoC said it expects growth to “stall” through the middle of 2023.

“The tightening of monetary policy initially slowed housing activity followed by consumer demand for durables in the middle of 2022,” the BoC said. “The effects of the rise in interest rates are expected to broaden and moderate consumer spending on services as well as investment spending in 2023.”

The Bank also confirmed it will be publishing its first summary of deliberations on its website on February 8.

“This summary will provide more insight into our decision-making,” Governor Tiff Macklem told reporters.

This follows recommendations from an International Monetary Fund review of the BoC’s transparency practices, in which it called on the Bank to begin publishing such summaries.

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Feature image by David Kawai/Bloomberg via Getty Images