The Bank of Canada announced another 50-basis-point increase in its overnight rate on Wednesday, to 1.5%, while it continued to shrink its balance sheet, another aggressive step in its campaign to tame inflation.
The move was expected given that the economy remains overheated, despite several rate hikes over the past few months.
Consumer and business spending are still strong, domestic demand is solid and unemployment is at record low. In addition, the war in Ukraine, lockdowns in China, and supply chain disruptions are keeping a constant upward pressure on inflation.
More importantly, the recent gross domestic product report shows that in addition to inflation staying above 3% in most categories, compensation growth is at nearly 4% compared to the first quarter of 2021, a sign of the elevated risks of entrenched inflation.
While oil prices and global supply chain bottlenecks remain outside of the Bank of Canada’s control, it can influence excess demand and inflation expectations, which it intends to use its tools to do.
The nearly immediate slowdown in the construction industry and the housing market shows that to an extent, the central bank’s actions are working, even though those actions will take a while longer for the impact of high interest rates to work through the economy.
Domestic demand in Canada remains strong, and household savings are way above where they were before the pandemic, which means that the economy can absorb this rate increase. But expect a slowdown in select sectors in the upcoming months as money gets more expensive to come by.
The hawkish tone in the bank’s announcement reassures that there will be at least another rate hike in July before the bank reassesses the economic environment, including inflation and economic growth.