OTTAWA—The Bank of Canada painted a rosier picture of the Canadian economy on April 18, with higher growth and inflation forecasts, after a slowdown in the first quarter. It held its key policy rate at 1.25 percent, as most expected, but did not provide more clarity on future rate hikes.
“Our uncertainty is about how much and at what pace,” said Bank of Canada Governor Stephen Poloz in his press conference regarding future rate increases.
Poloz stressed that the central bank is very much data-dependent.
“The pace is a significant question mark for us given the data,” he said.
The Canadian economy is operating at close to capacity. As slack in various parts of the economy has been evaporating for the past three quarters while the BoC raised rates three times, inflation has been steadily rising to the 2 percent target.
The BoC repeated that “higher interest rates will be warranted over time,” although rates need to remain accommodative to keep inflation on target. There is still considerable stimulus in the economy given that the bank’s estimate for the neutral rate—the equilibrium rate for the economy operating at potential and with inflation at target—is still between 2.5 percent and 3.5 percent.
“The economy’s in a good place,” Poloz said. But he caveated that all is not quite normal and that without interest rates being so low, the economy wouldn’t be where it is today. Thus, the economy still needs considerable support from accommodative monetary policy.
This speaks to an ongoing gradual pace of rate hikes, an economy that still needs time to build capacity, and the particular Canadian situation of a high sensitivity to rising rates given elevated consumer debt levels.
“Everything is consistent with a gradual tightening path, which is what we’ve been expecting,” said Andrew Kelvin, senior rates strategist at TD Securities, in a phone interview.
Kelvin forecasts one more rate hike in 2018 and another in January 2019—similar to market expectations. He said markets are almost certain of a rate hike in July and are settling on closer to two rate increases a year as opposed to three.
Inflation Responds
Inflation in advanced economies—Canada’s included—has been below target for years despite extraordinarily low interest rates and government bond purchase programs in many jurisdictions.
Poloz said inflation has moved up from its trough last summer as the bank’s models predicted and that the issue was excess capacity being greater than originally measured.
