Bank of Canada Opts for Rate Hike, Ending Pause

The Bank of Canada, which in January paused a series of interest rate hikes, resumed its monetary tightening with a 25-basis-point increase on Wednesday.

The move surprised economic analysts, who expected the rate hike pause to continue. It also signaled a continued willingness by Canada’s central bank to chart a different course than the Federal Reserve, which is widely reported to be considering a pause in rate hikes at its meeting later this month.

BOC cited an overheating economy and persistent inflation as primary reasons for the course correction, which raises the overnight lending rate to 4.75%, its highest level in Canada since April 2001.

BOC said Canada’s gross domestic product grew at an annualized rate of 3.1% in the first quarter, significantly higher than what the bank had expected. In April, Canada’s inflation rate rose for the first time since last June, hitting 4.4%.

The inflation rate in Canada is half of what it was last June, when it peaked at 8.1%, but still more than twice as much as the BOC’s target of 2% when it initiated a series of eight consecutive rate increases last year. Unemployment in Canada is currently 5%.

“Based on the accumulation of evidence, [the] Governing Council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the two percent target,” BOC bank said in a news release announcing its decision, the Toronto Star reported.

Some analysts questioned the wisdom of BOC’s move, suggesting that the central bank was going to intensive an approaching global recession.

“We’re already looking at the strong probability of a recession in the next year,” said Jim Stanford, chief economist the Centre for Future Work, told the Star. “The last thing that’s needed is more of the wrong medicine.”

In its statement, BOC said higher immigration rates in Canada are “expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labor.”

A recent Monetary Policy Report from BOC indicated that an unemployment rate of between 5.7% to as high as 7.5% might be needed to tamp inflation down to the 2% target.

However, according to a report from the Conference Board of Canada, some leading indicators are pointing to a slowdown: Canadian households were saving just 2.8% of their gross income in the first quarter, down from almost 6% in the fourth quarter, which the board interpreted as a sign that higher interest rates are pinching household finances.

In March, when BOC affirmed that it would continue the rate increase pause despite a continuation of rate hikes in the US, a senior deputy governor at BOC said Canada’s central bank needed to chart its own course and do what’s best for Canada.

“We are seeing inflationary pressures come down a little more than they’re seeing in the US,” Carolyn Rogers said, in a March speech in Winnipeg. “While we’re always thinking globally, we have to act locally. We must tailor our policy to Canadian circumstances.”

“As global inflationary pressures recede, each country will need to chart its own course to get back to price stability,” she added.