The Bank of Canada held its key interest rate steady at five per cent on Wednesday, September 6, 2023, despite previous indications that it was open to further increases if necessary. The decision comes amid growing evidence that the higher interest rates are affecting economic activity and follows news that the Canadian economy contracted in the second quarter.
The central bank has raised its key interest rate ten times since March 2022, taking it from near-zero to its highest level in 22 years. This aggressive rate-hike campaign was initiated to combat inflation, which peaked at 8.1 per cent in June but has since dropped to 3.4 per cent. The bank now anticipates that inflation will not reach its target of two per cent until mid-2025, six months later than previously forecasted.
In a news release, the Bank of Canada noted that "with recent evidence that excess demand in the economy is easing, and given the lagging effects of monetary policy, governing council decided to hold the policy interest rate at five per cent." However, it also stated that it is prepared to raise interest rates further if needed due to ongoing concerns about inflationary pressures.
Last week, Statistics Canada reported that the Canadian economy shrank at an annualized rate of 0.2 per cent in the second quarter, contrary to the central bank's forecast of a 1.5 per cent growth. This contraction likely influenced the decision to halt rate hikes this week.
Douglas Porter, chief economist at BMO (TSX:BMO), commented on the state of the economy: “It would be a very brave bank indeed to be hiking interest rates when GDP is falling.”
Two provincial premiers — Ontario's Doug Ford (NYSE:F) and B.C.'s David Eby — had previously urged the bank not to raise rates again, citing concerns over the impact on struggling Canadian households. In an open letter to bank governor Tiff Macklem last Sunday, Ford wrote: “Consider the effect higher interest rates are having on everyday people.”
Despite this pause on rate hikes, economists estimate it takes about one to two years for a rate hike to fully affect demand and business activity. Therefore, these rate hikes are expected to continue influencing the economy by slowing consumer demand and dampening business investment. The labour market has also shown signs of weakening with the unemployment rate increasing for three consecutive months.
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