This morning in its first scheduled policy decision of 2022, the Bank of Canada left its target overnight benchmark rate unchanged at what it describes as its “lower bound” of 0.25%. As a result, the Bank Rate stays at 0.5% and the knock-on effect is that borrowing costs for Canadians will remain low for the time being.
The Bank also updated its observations on the state of the economy, both in Canada and globally, leaving a strong impression that rates will rise this year.
More specifically, the Bank said that its Governing Council has decided to end its extraordinary commitment to hold its policy rate at the effective lower bound and that looking ahead, it expects “… interest rates will need to increase, with the timing and pace of those increases guided by the Bank’s commitment to achieving” its 2% inflation target.
These are the other highlights of today’s BoC announcement.
Canadian economy
- The economy entered 2022 with considerable momentum, and a broad set of measures are now indicating that economic slack is absorbed
- With strong employment growth, the labour market has tightened significantly with elevated job vacancies, strong hiring intentions, and a pick up in wage gains
- Elevated housing market activity continues to put upward pressure on house prices
- Omicron is “weighing on activity in the first quarter” and while its economic impact will depend on how quickly this wave passes, the impact is expected to be less severe than previous waves
- Economic growth is then expected to bounce back and remain robust over the Bank’s “projection horizon,” led by consumer spending on services, and supported by strength in exports and business investment
- After GDP growth of 4.5% in 2021, the Bank expects Canada’s economy to grow by 4% in 2022 and about 3.5% in 2023
Canadian inflation
- CPI inflation remains “well above” the Bank’s target range and core measures of inflation have edged up since October
- Persistent supply constraints are feeding through to a broader range of goods prices and, combined with higher food and energy prices, are expected to keep CPI inflation close to 5% in the first half of 2022
- As supply shortages diminish, inflation is expected to decline “reasonably quickly” to about 3% by the end of 2022 and then “gradually ease” towards the Bank’s target over the projection period
- Near-term inflation expectations have moved up, but longer-run expectations remain anchored on the 2% target
- The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation
Global economy
- The recovery is strong but uneven with the US economy “growing robustly” while growth in some other regions appears more moderate, especially in China due to current weakness in its property sector
- Strong global demand for goods combined with supply bottlenecks that hinder production and transportation are pushing up inflation in most regions
- Oil prices have rebounded to well above pre-pandemic levels following a decline at the onset of the Omicron variant of COVID-19
- Financial conditions remain broadly accommodative but have tightened with growing expectations that monetary policy will normalize sooner than was anticipated, and with rising geopolitical tensions
- Overall, the Bank projects global GDP growth to moderate from 6.75% in 2021 to about 3.5% in 2022 and 2023
January Monetary Policy Report
The key messages found in the BoC’s Monetary Policy Report published today were consistent with the highlights noted above:
- A wide range of measures and indicators suggest that economic slack is now absorbed and estimates of the output gap are consistent with this evidence
- Public health measures and widespread worker absences related to the Omicron variant are slowing economic activity in the first quarter of 2022, but the economic impact is expected to be less severe than previous waves
- The impacts from global and domestic supply disruptions are currently exerting upward pressure on prices
- Inflationary pressures from strong demand, supply shortages and high energy prices should subside during the year
- Over the medium term, increased productivity is expected to boost supply growth, and demand growth is projected to moderate with inflation expected to decline gradually through 2023 and 2024 to close to 2%
- The Bank views the risks around this inflation outlook as roughly balanced, however, with inflation above the top of the Bank’s inflation-control range and expected to stay there for some time, the upside risks are of greater concern
Looking ahead
The Bank intends to keep its holdings of Government of Canada bonds on its balance sheet roughly constant “at least until” it begins to raise its policy interest rate. At that time, the BoC’s Governing Council will consider exiting what it calls its “reinvestment phase” and reducing the size of its balance sheet. It will do so by allowing the roll-off of maturing Government of Canada bonds.
While the Bank acknowledges that COVID-19 continues to affect economic activity unevenly across sectors, the Governing Council believes that overall slack in the economy is now absorbed, “thus satisfying the condition outlined in the Bank’s forward guidance on its policy interest rate” and setting the stage for increases in 2022.