BANK OF CANADA BELIEVES INTEREST RATES NEED MORE TIME TO WORK, MINUTES REVEAL
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The Bank of Canada believes current interest rates are high enough to bring inflation under control, but will not contemplate cutting them until it is convinced price stability has been restored.
The central bank left its key overnight interest rate at five per cent last month and central bankers are now weighing how much longer it will have to be maintained at that level, according to a summary of the deliberations that led to the Jan. 24 hold decision. Still, with core inflation of around 3.5 per cent and wage growth remaining elevated, the bank’s governing council did not see enough indications to lower the key overnight rate.
“The current stance of monetary policy was relieving price pressures, but more time was needed to restore price stability,” the central bankers concluded, adding that members of the governing council were in agreement that interest rates appeared to be “sufficiently restrictive” to ultimately meet their inflation target.
To justify a rate cut, the central bankers said they would need to see further evidence of progress toward price stability and clear downward momentum in underlying inflation, according to the summary of deliberations, released Feb. 7.
They looked at scenarios that would hasten or delay a rate cut. In the first scenario, monetary policy could have a greater impact on consumer spending than expected, particularly with consumer confidence already low
“This could cause a marked contraction in economic activity, a larger and more rapid rise in the unemployment rate and more disinflationary pressure than expected,” the central bankers said. “In this scenario, monetary policy would likely need to ease earlier and more quickly than anticipated.”
By contrast, monetary policy would need to remain restrictive for longer if inflation is more persistent than expected, even with economic growth slowing.
“This could happen if near-term inflation expectations remained elevated and the growth of unit labour costs and shelter costs did not moderate,” the central bankers concluded.
The summary of deliberations said the Bank of Canada is watching several key indicators, including the balance of supply and demand in the economy, corporate pricing behaviour, inflation expectations and wage growth relative to productivity.
Central bankers noted that labour market conditions were easing and corporate pricing behaviour was “normalizing” as a steep increase in rates over an 18-month period beginning in the spring of 2022 continued to work its way through the system.
However, members of the governing council agreed the indicators they’re watching “painted a mixed picture” of underlying inflation and that more time was needed for past interest rate increases to relieve price pressures.
“With inflation still too high and too broad-based, members wanted to be clear in their communications that they were still concerned about the persistence of underlying inflation.”
The central bankers said higher rates were acting to slow the Canadian economy, and they agreed they had to continue to balance the risks of over tightening with the risks of doing too little to control inflation.
“While members did not want to make economic conditions more painful than necessary, they were particularly concerned about the persistence of inflation and did not want to lower interest rates prematurely, only to have to raise them again to get inflation back to the two per cent target,” the summary of deliberations said.
The central bank’s governing council expected the economy to be weak in the near term and members agreed that, if the economy evolved in line with this projection, it would likely lead to further easing in inflationary pressures.
“However, members remained concerned about the risks to the outlook for inflation, particularly the persistence of underlying inflation,” according to the summary of deliberations.
Story by: Financial Post