Bank of Canada Delivers Rate Hold, But What’s Next?

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The Bank of Canada delivered its second straight rate hold, but signalled that it remains concerned about inflationary risks and price pressures.

As was widely expected, the Bank left its overnight target rate at 5.00%, which means prime rate will stay at 7.20% for variable-rate mortgage borrowers.

In its statement, the Bank noted it is seeing “clearer signs that monetary policy is moderating spending and relieving price pressures,” although not quite as quickly as the Bank would prefer.

“Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed,” the statement continued.

Despite the improvements made on the inflation front and the reduction in underlying demand, economists say it remains too soon for the Bank to let down its guard.

“…price and wage growth remain too fast for the BoC to back off its hawkish rhetoric just yet,” wrote BMO’s Douglas Porter.

“To act on that hawk talk would take either a big rebound in growth, a renewed acceleration in inflation, or perhaps a considerably weaker Canadian dollar,” he added. “We assume none of those forces will weigh in, and look for the Bank to remain on hold deep into 2024.”

James Orlando at TD Economics agrees that the BoC is likely to retain its hawkish bias.

“It needs to maintain current tight financial conditions in order to achieve its forecasted slowdown,” he noted. “And while markets are hesitant to build in another hike, the impact of the BoC’s rhetoric has resulted in a higher for longer path for the BoC’s policy rate.”

As a result, the Government of Canada 10-year bond yield is now at its highest level since 2007.

BoC trims its GDP growth forecasts

Today’s decision was also accompanied by the Bank of Canada’s latest Monetary Policy Report, which included the Bank’s updated economic projections.

GDP forecast

Notably, the Bank revised down its GDP growth forecasts as the impacts of the Bank’s previous rate hikes are now starting to take hold. It now sees economic growth averaging around just 1% for this year and next before picking up steam again in 2025.

The Bank now expects annual economic growth of:

1.2% in 2023 (vs. 1.8% in its previous forecast)
0.9% in 2024 (vs. 1.2%)
2.5% in 2025 (vs. 2.4%)

Inflation

Meanwhile, the Bank revised its inflation forecasts in the opposite direction.

“…in addition to elevated mortgage interest costs, inflation in rent and other housing costs remains high,” the Bank said. “Near-term inflation expectations and corporate pricing behaviour are normalizing only gradually, and wages are still growing around 4% to 5%. The Bank’s preferred measures of core inflation show little downward momentum.”

3.9% in 2023 (vs. 3.7% in its previous forecast)
3.0% in 2024 (vs. 2.5%)
2.2% in 2025 (vs. 2.1%)

The lagged impact of rate hikes on Canadian households

Despite today’s rate hold, more households will become exposed to higher interest rates and higher monthly payments as their mortgages come up for renewal.

“This should all help to weigh on activity and dampen price pressures, potentially opening the door for rate cuts in mid-2024,” note economists at ING.

The Bank noted the impact higher rates have had on mortgage credit growth, which has slowed from a pace of 9.9% (on an annualized three-month basis) in February 2022 to just 3.5% as of August 2023.

In its MPR, the Bank also addressed the impact of higher rates on overall household financial health.

“As interest rates have increased, measures of household financial stress have risen from the lows observed during the height of the pandemic,” it said, adding that indicators of financial stress are being felt more acutely by non-mortgage holders.

“Although delinquency rates for mortgage products have remained close to their
all-time lows, the share of borrowers falling behind on payments by 60 days
or more has continued to increase for most credit products,” the Bank said, noting that delinquency rates for auto loans are now above pre-pandemic levels.

The Bank of Canada’s next rate decision is scheduled for December 6, 2023.