The Bank of Canada kept its policy rate at 5% on Wednesday as the unexpected contraction of the economy in the second quarter gave a clear message of a cooling economy.
The central bank’s decision to keep rates steady also suggested that its campaign of rate increases might be over, rendering a rate peak of 5%.
Monetary policies designed to cool the economy are working, but the Bank of Canada does not want to over-tighten. Further rate hikes risk pushing the economy into a recession and result in more job losses than necessary.
The signs of a slowdown are plenty, including declines in housing investments, consumer spending on services and job vacancies.
The economy unexpectedly contracted in the second quarter as a result of lower housing investments, consumer spending on services, and worker strikes. Growth for the rest of the year is expected to be weak as labour demand moderates.
Inflation will stay high for a few more months before easing because of base-year effects as well as the recent creeping up of gasoline prices.
Read more of RSM Canada’s insights about the economy and the middle market.
The central bank indicated that it would continue policy normalization and monitor the data. Wage growth remains elevated, partly because of renegotiated contracts by unions, which means more spending power that could push up inflation again. That said, the cycle of pent-up demand is likely over.
The central bank will hold its policy rate of 5% into next year to keep inflation expectations anchored and ensure that price stability is restored. A premature rate cut could send businesses and consumers out borrowing and spending, and risk reaccelerating inflation again.
The takeaway
It takes time for the economy to absorb the lagged impact of the recent rate hikes, and the impact is finally coming into view. Businesses and consumers will need to adjust to a fall and winter of restrictive monetary policy.
