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Bank of Canada Maintains Key Interest Rate at 5% Amidst Inflation Concerns
The Bank of Canada (BoC) announced on Wednesday that it would keep its key overnight interest rate steady at 5%. The central bank had previously increased rates by a quarter point in both June and July to combat persistently high inflation, which had remained above the bank’s 2% target for 27 consecutive months.
Canada faced an economic quandary in the second quarter as its gross domestic product (GDP) took an unexpected dip, contracting by an annualized 0.2%. This downturn has sent ripples of concern through the nation, raising apprehensions that Canada may already find itself on the brink of a recession.
In contrast to the GDP contraction, the specter of inflation looms large. In July, inflation surged to a notable 3.3%, with core measures stubbornly holding their ground at around 3.5%. This persistent price pressure had pushed the Bank of Canada (BoC) to a crossroads.
The BoC’s decision to maintain its policy interest rate at 5% was met with intrigue. The central bank, in its statement, illuminated the rationale behind this choice. It pointed to recent evidence that indicates a reduction in excess demand within the economy. Furthermore, it took into consideration the time-lagged effects of monetary policy, emphasizing the necessity for a cautious and measured approach.
This decision represents the BoC’s commitment to carefully balancing the need for economic stability with the imperative to curb inflation. It acknowledges that while economic growth may be waning, the threat of rising prices still looms large. In doing so, the BoC seeks to steer the Canadian economy through the challenging waters of uncertain times, striving to ensure that the nation remains on a stable course.
BoC’s Hawkish Stance and Market Reactions
The bank also indicated that it was prepared to raise interest rates further if inflationary pressures persisted, although analysts believed that this hawkish stance might not lead to immediate rate hikes.
The Bank has not ruled out the potential for additional rate increases. However, unless there is a substantial improvement in economic growth in the third quarter, which we have reservations about, it is probable that the BoC will abstain from implementing any further rate hikes,” commented Doug Porter, who serves as the chief economist at BMO Capital Markets.
The Canadian dollar weakened slightly, trading at 1.3655 against the US dollar, down 0.1%, after reaching a five-month low of 1.3676.
The Canadian 2-year yield was 6.3 basis points lower than its US counterpart, resulting in a 36.5 basis point gap in favor of the US note.
Money markets had only assigned a 14% probability of a rate hike at the current meeting. Thirty-one out of 34 economists polled by Reuters between August 24-30 had expected no change in the central bank’s overnight rate.
The Canadian dollar weakened slightly, trading at 1.3655 against the US dollar, down 0.1%, after reaching a five-month low of 1.3676.
The Canadian 2-year yield was 6.3 basis points lower than its US counterpart, resulting in a 36.5 basis point gap in favor of the US note.
Money markets had only assigned a 14% probability of a rate hike at the current meeting. Thirty-one out of 34 economists polled by Reuters between August 24-30 had expected no change in the central bank’s overnight rate.
Economic Outlook and BoC’s Strategy
We foresee a gradual economic recovery ahead, with the third quarter likely to witness sluggish growth,” shared insights Andrew Kelvin, the chief Canada strategist at TD Securities. He continued, “Furthermore, we anticipate that the Bank of Canada (BoC) will keep interest rates unchanged during the upcoming October and December meetings.”
Scheduled for Thursday, Bank of Canada Governor Tiff Macklem is expected to address the public through a speech and press conference to elaborate on the forthcoming decisions and economic outlook.
Inflation and Political Implications
The BoC pointed out that recent increases in gasoline prices, which were higher than anticipated in its previous economic forecasts from July, would lead to a short-term increase in inflation before easing.
On the flip side, the high interest rates, at their highest level in 22 years, are restraining spending among a broader range of borrowers. The economy has entered a phase of weaker growth, which is seen as necessary to alleviate inflationary pressures.
Inflation had reached a four-decade high of 8.1% in the previous year, prompting the BoC to raise interest rates ten times since March 2022 in an effort to bring it back in line with the target.
Liberal Prime Minister Justin Trudeau’s popularity had waned due to high inflation, with Conservative rival Pierre Poilievre accusing him of contributing to inflation through government spending and exacerbating the housing crisis with rate hikes.
Finance Minister Chrystia Freeland welcomed the Bank of Canada’s decision to maintain the overnight interest rate, describing it as a relief for Canadians.
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