A Forceful Fifty

By Taylor Schleich & Warren Lovely

National Bank of Canada, Financial Markets

Rate Statement

For the second consecutive meeting, the Bank of Canada opted to increase its overnight rate target by 50 basis points, a decision that was fully anticipated by the market and forecasters alike. This move brings the overnight target to 1.50%, half a percentage-point shy of the range that the Bank considers neutral (2.0–3.0%). Consistent with the last two rate hikes, the Bank also raised its deposit rate proportional to the overnight target (i.e., by 50 bps to 1.50%. In ‘normal times’ the deposit rate is set 25 basis points below the overnight target). As for interest rate guidance, the statement reiterated that “interest rates will need to rise further” (unchanged from April). In addition, the BoC added more hawkish guidance: “The Governing Council is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.”.

When it comes to the BoC’s balance sheet, there’s nothing new to report here. With the BoC’s April decision ushering in the start of quantitative tightening, balance sheet run-off is now on autopilot, dictated by the Bank’s bond holdings.

Elsewhere in the rate statement, the Bank highlighted another upside surprise to inflation "well above the Bank’s forecast”. They note that inflation is likely to move even higher in the near term before beginning to ease. The statement also stressed the “pervasive” nature of input price pressures that are continuing to feed into broadening consumer prices, increasing the risk elevated that inflation becomes entrenched. On the growth front, the statement highlights that the world economy is slowing. However, it also stresses that Canadian economic activity is “strong”, and the economy is “clearly” operating in excess demand, amidst widespread labour shortages. Looking ahead, consumer spending is expected to remain “robust” and Q2 growth should be “solid”. Finally, on the housing market, the statement simply noted that activity is moderating from “exceptionally high levels”.

Bottom Line

While the aggressive 50 basis point move had been fully anticipated, the BoC still managed to deliver a hawkish surprise. In addition to reiterating April’s guidance that “rates need to rise further”, the statement added that the Governing Council is “prepared to act more forcefully if needed”. It wasn’t just the guidance that was more aggressive either. The inflation backdrop was brought to the top of the statement and was littered with strong language. “Pervasive input price pressures” and “broadening” core inflation/wage growth means the risk of entrenched elevated inflation has increased. Meanwhile, the economy is “clearly” operating in excess demand, with consumer spending in Canada “remaining robust”.

It’s obvious the BoC would like to expeditiously return to a neutral/normal policy setting and as a result, another outsized hike in July is all but assured. However, the sense of urgency (panic?) from the Bank is more acute than we’d anticipated. While still not our base case, we now view the odds of a 75 basis point move in July as non-trivial. To inform that view, we’ll have just one additional CPI report in the intervening period. We know headline inflation will tick up again thanks to higher gas prices but a further significant broadening in core measures could tip the scale.

Though its clear the Bank will remain hawkish near-term, the key question that lingers is: will the BoC have to hike into restrictive territory (i.e., above 3%) late this year/early next year? We had expected the Bank to slow down its pace of rate hikes after July (i.e., to 25 basis point moves), ultimately tapping out at 2.50% before the year is out. However, the level of concern conveyed in today’s statement suggests that outsized rate moves might continue for longer, making an outright restrictive policy setting more likely. On this front, we’ll be closely watching Deputy Governor Paul Beaudry’s speech and press conference tomorrow to hopefully get a bit more insight into the Bank’s thinking.

The Bank’s next policy meeting is scheduled for July 13th and will be come with an updated Monetary Policy Report.

Here is the interest rate statement:

Bank of Canada increases policy interest rate by 50 basis points, continues quantitative tightening The Bank of Canada today increased its target for the overnight rate to 1½%, with the Bank Rate at 1¾% and the deposit rate at 1½%. The Bank is also continuing its policy of quantitative tightening (QT).

Inflation globally and in Canada continues to rise, largely driven by higher prices for energy and food. In Canada, CPI inflation reached 6.8% for the month of April – well above the Bank’s forecast – and will likely move even higher in the near term before beginning to ease. As pervasive input price pressures feed through into consumer prices, inflation continues to broaden, with core measures of inflation ranging between 3.2% and 5.1%. Almost 70% of CPI categories now show inflation above 3%. The risk of elevated inflation becoming entrenched has risen. The Bank will use its monetary policy tools to return inflation to target and keep inflation expectations well anchored.

The increase in global inflation is occurring as the global economy slows. The Russian invasion of Ukraine, China’s COVID-related lockdowns, and ongoing supply disruptions are all weighing on activity and boosting inflation. The war has increased uncertainty and is putting further upward pressure on prices for energy and agricultural commodities. This is dampening the outlook, particularly in Europe. In the United States, private domestic demand remains robust, despite the economy contracting in the first quarter of 2022. US labour market strength continues, with wage pressures intensifying. Global financial conditions have tightened and markets have been volatile.

Canadian economic activity is strong and the economy is clearly operating in excess demand. National accounts data for the first quarter of 2022 showed GDP growth of 3.1 percent, in line with the Bank’s April Monetary Policy Report (MPR) projection. Job vacancies are elevated, companies are reporting widespread labour shortages, and wage growth has been picking up and broadening across sectors. Housing market activity is moderating from exceptionally high levels.

With consumer spending in Canada remaining robust and exports anticipated to strengthen, growth in the second quarter is expected to be solid. With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the Governing Council continues to judge that interest rates will need to rise further. The policy interest rate remains the Bank’s primary monetary policy instrument, with quantitative tightening acting as a complementary tool. The pace of further increases in the policy rate will be guided by the Bank’s ongoing assessment of the economy and inflation, and the Governing Council is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.

Information note: The next scheduled date for announcing the overnight rate target is July 13, 2022. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the MPR at the same time.