Bank of Canada hikes rates and strikes hawkish tone on sticky inflation

By Steve Scherer and Ismail Shakil

OTTAWA (Reuters) -The Bank of Canada (BoC) on Wednesday hiked its key overnight rate by a quarter of a percentage point to a 22-year high of 5.0%, saying it feared that efforts to return inflation to its 2% target could stall amid excess consumer spending.

The move to increase borrowing costs by 25 basis points for the second time in as many months was expected by analysts and markets. After a five-month pause, the BoC raised its overnight rate in June saying monetary policy was not sufficiently restrictive.

The BoC in its statement dropped the line saying rates were not restrictive enough but it revised higher its growth forecast for this year and pushed back its expectations for getting inflation to target by six months to mid-2025.

BoC governing council members “still sound open to further tightening,” said Derek Holt, vice president of capital markets economics at Scotiabank. “So I think they’re just taking the summer off.”

Canadian money markets increased bets for another rate increase after the move, seeing an almost 40% probability of another hike at the next policy announcement in September.

The Canadian dollar strengthened to 1.3157 versus the U.S. dollar after the rate hike, up 0.6% on the day.

“With three-month measures of core inflation running in the 3.5%-4% range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2% target,” the BoC said in a statement.

Despite nine previous rate increases totaling 450 basis points since March of last year, the economy regained momentum in May, likely growing 0.4% on the month, after stalling in April.

“They are done for now (with more hikes). However, today’s tone does communicate a risk of another possible hike in September,” said Andrew Kelvin, chief Canada strategist at TD Securities.

The BoC raised its forecast for second-quarter annualized quarterly growth to 1.5% from 1.0% in April, and growth is seen expanding 1.5% also in the third quarter. Overall 2023 real gross domestic product growth is seen at 1.8% compared with its April forecast of 1.4%.

“The rebalancing of supply and demand is now expected to happen in early 2024,” the BoC said it its report containing new forecasts also released on Wednesday.

Though headline inflation slowed to 3.4% in May, less than half of last year’s 8.1% peak, the three-month annualized rates of the BoC’s core measures have not been coming down.

Surprisingly persistent demand, higher-than-expected housing costs and a more gradual decline than expected in goods prices, excluding food and energy, are fueling inflation, the BoC said.

“Inflation is expected to return to 2% in the middle of 2025, although the timing is uncertain given the gradual movement of inflation toward the target,” the BoC said.

The BoC’s overnight target rate was last at 5.00% in March and April of 2001.

Twenty of 24 economists surveyed by Reuters had expected the central bank to lift rates by a quarter of a percentage point. Money markets had seen a more than a 70% chance of a rate hike before the announcement.

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