The Bank of Canada increased its policy rate by 75 basis points on Wednesday, bringing the overnight rate to 3.25%, and said that it would continue to reduce its balance sheet.
The rate hike came as no surprise, with inflation still pervasive. While economic growth has moderated abroad and at home—Canada’s gross domestic product rose at a 3.3% rate in the second quarter, below expectations—the labour market is still tight and the unemployment rate is at an all-time low of 4.9%.
In addition, domestic consumer demand and business investment still indicate a healthy economy.
Housing has cooled following back-to-back rate hikes, which was expected following the overheated market of the past two years.
Even though housing plays an outsized role in the Canadian economy, making up nearly 10% of GDP, this is a sector-specific contraction and is not indicative of the broader economy.
A decline in housing alone does not mean the economy is in recession, so this time, a large rate hike is appropriate.
There are early signs that inflation may have peaked. Gasoline prices have dropped to about 1.59 per liter on average, and more declines are expected. For this reason, inflation might continue to fall in September.
Still, now is not the time for the Bank of Canada to back off its rate increases. Risks in the economy, particularly volatile geopolitical conditions, might keep prices high for some time.
In addition, the central bank is focused on dampening medium- and long-term inflation expectations to make sure that inflation does not become entrenched.
The takeaway
The road to price stability requires consistent actions. We expect more interest rate hikes to bring the policy rate to 4% by the end of the year.
