Bank of Canada puts conditional pause on rate hike, feels country turning corner on inflation

In his recent speech, the Bank of Canada’s governor said that quantitative tightening is showing results and inflation is down from 8.1% in June to 6.3% in December, with people spending less on housing and high ticketed items like appliances and furniture. He feels that Canada is turning the corner on inflation and if the economy remains on track as forecasted, soon it will reach the target of 2%. However, despite this progress, Canadians are still feeling the hardship of high inflation in their essential household expenses, with persistent price increases for food and shelter. How will the Central bank balance between over and under tightening of the economy as over tightening could lead to depression and under tightening would not control inflation.
By Surbhi Gogia
The Bank of Canada raised its benchmark interest rate again, to 4.5 per cent. But said that after raising the rates rapidly, “it’s time to pause”.
The Bank’s governor Tiff Macklem, however, made it clear that this is a “conditional pause” that will depend on whether economy continues to develop according to the Bank’s Monitory Policy Report (MPR) forecast.
He said the Bank’s target is to bring down the inflation to 2%. Wednesday’s decision marks the eighth consecutive time the Bank of Canada has raised the cost of borrowing. “To combat inflation, the Bank of Canada responded forcefully, raising its policy interest rate from 0.25% a year ago to 4.50% today. It’s working. We are turning the corner on inflation,” he said.
But he made it clear that the bank wanted to balance the risks of under- and over-tightening the economy. “If we do too little, the decline in inflation will stall before we get back to target. But if we do too much, we will make the adjustment unnecessarily painful and undershoot the inflation target.”
For that reason, there is a modest rate hike and a hold on interest rate but at the same time the central bank would not shy away from increasing the rate further if the inflation continues and is prepared to increase the policy rate further if needed to return inflation to the 2% target. 
He explained that globally, inflation remains high and broad-based. Although it has receded from its peak in many countries, largely due to lower energy prices and an easing of supply chain disruptions, it is still far too high and uncertain. “Many central banks have continued to increase policy rates to slow demand and bring inflation down.”
Russia’s invasion of Ukraine continues to create uncertainty, particularly in Europe. China’s abrupt lifting of COVID-19 restrictions is a new uncertainty which poses upside risks to global commodity prices.
The Bank estimates the global economy grew by about 3½% in 2022, and will slow to about 2% in 2023 and 2½% in 2024. This projection is slightly higher than October’s.
In Canada, recent economic growth has been stronger than expected and the economy remains in excess demand. The Bank estimates Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in October.
“In Canada, the economy remains overheated and clearly in excess demand. Tight labour markets have shown only modest signs of easing. Job vacancies have come down a little but remain elevated, the unemployment rate is near historic lows, and many businesses continue to report labour shortages.”
However, there is growing evidence that restrictive monetary policy is slowing activity, especially household spending. “Household spending has moderated. Demand for furniture and appliances has decreased, and housing market activity and prices have declined substantially. As pent-up demand diminishes, spending on services should ease. Higher rates are also expected to continue to slow business investment, and weaker foreign demand will weigh on exports,” he said.
As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment are expected to slow. Meanwhile, weaker foreign demand will likely weigh on exports. This overall slowdown in activity will allow supply to catch up with demand.
“Putting this together, we expect growth in Canada to stall through the middle of this year before picking up later in the year. We project that, on an annual average basis, growth in Canada’s gross domestic product will slow from about 3½% in 2022 to about 1% in 2023 and 2% in 2024,” he added.
According to the Bank of Canada, inflation has declined from 8.1% in June to 6.3% in December, reflecting lower gasoline prices and, more recently, moderating prices for durable goods.
Despite this progress, Canadians are still feeling the hardship of high inflation in their essential household expenses, with persistent price increases for food and shelter. Short-term inflation expectations remain elevated.
“The decline in inflation since the summer is welcome relief for the many Canadians who are struggling to keep up with the rising cost of living. But at more than 6%, inflation remains too high,” he said.
Inflation is projected to come down significantly this year. Lower energy prices, improvements in global supply conditions, and the effects of higher interest rates on demand are expected to bring CPI inflation down to around 3% in the middle of this year and back to the 2% target in 2024.
“We’re still a long way from our target, but recent developments have reinforced our confidence that inflation is coming down.”
The Bank is prepared to increase the policy rate further if needed to return inflation to the 2% target.