Bank of Canada building

The Bank of Canada held its key interest rate steady at 5% on Wednesday, but hasn’t ruled out future rate hikes as its latest projections show inflation remaining higher in the short term.

“With clearer evidence that monetary policy is working, governing council’s collective judgment was that we could be patient and hold the policy rate at 5%. We will continue with that to assess whether monetary policy is sufficiently restrictive, to restore price stability, and we will monitor risks closely,” Governor Tiff Macklem said in a news conference.

“If inflationary pressures persist, we are prepared to raise our policy rate further to restore price stability,” he warned.

Higher interest rates appear to be having their intended effect on the economy: growth is stalling, consumer spending is slowing and the job market is softening.

Meanwhile, inflation resumed its decline in September, falling to 3.8% as price pressures eased across the economy.

BMO chief economist Douglas Porter said although he doesn’t expect the central bank will need to raise interest rates again, it is too soon to rule out the possibility.

“I do think they have a bias to hike rates again, if need be,” Porter said. “It probably wouldn’t take that much to get them to hike rates.”

The Bank of Canada’s hawkish tone was anticipated by economists, given underlying price pressures have remained stubbornly high.

“Although the BoC has painted a clear picture for why it doesn’t need to hike again, we expect its hawkish rhetoric to persist,” said TD director of economics, James Orlando, in a client note.

That’s because it needs to maintain tight financial conditions to ensure both growth and inflation continue along the Bank of Canada’s projected trajectory, he added.

The central bank published its quarterly monetary policy report on Wednesday, which includes new economic forecasts that suggest slower economic growth and higher inflation in the short-run.

Real gross domestic product is projected to grow 1.2% in 2023, down from 1.8% in its previous forecast.

Meanwhile, growth is expected to come in weaker in 2024 – with real GDP rising by 0.9% – and to rebound to 2.5% in 2025.

The central bank still believes inflation will return to the 2% target in 2025, as previously forecast. However, it anticipates inflation to be higher in the short term, averaging about 3.5% through the middle of 2024.

Macklem said the new forecasts suggest the path toward a “soft landing” – getting inflation down to 2% without a sharp economic downturn – has narrowed.

“We’ve been saying for some time, the path to a soft landing is narrow. And in this projection, that path has gotten narrower,” the governor said.

When asked whether this period of lower growth and high inflation would qualify as stagflation, Macklem said “it’s not a word I would use.”

“I grew up in the 1970s. Stagflation to me is a period of high inflation and high unemployment. That’s not what we’re in now,” Macklem said, adding that the unemployment rate is still quite low.

Looking ahead, the monetary policy report outlines some risks surrounding its forecasts, including the war between Israel and Hamas. With oil prices right now higher than previously expected, the central bank says an escalation of the war into a broader regional conflict could disrupt global oil supplies.

Macklem also weighed in on the impact government spending is having on inflation, noting that federal and provincial budgets in aggregate will add to inflation over the next year.

“If all those spending plans are realized, government spending will be adding to demand more than supply is growing. And in an environment where we’re trying to moderate spending and get inflation down, that’s not helpful,” Macklem said.

“It would be helpful if governments considered the inflationary impact of their spending decisions when they’re making their spending plans. It’s going to be easier to get inflation down if monetary and fiscal policy are rowing in the same direction.”

Here is the text of the central bank’s decision:

The Bank of Canada today held its target for the overnight rate at 5%, with the Bank Rate at 5.25% and the deposit rate at 5%. The Bank is continuing its policy of quantitative tightening.

The global economy is slowing and growth is forecast to moderate further as past increases in policy rates and the recent surge in global bond yields weigh on demand. The Bank projects global GDP growth of 2.9% this year, 2.3% in 2024 and 2.6% in 2025. While this global growth outlook is little changed from the July Monetary Policy Report (MPR), the composition has shifted, with the US economy proving stronger and economic activity in China weaker than expected. Growth in the euro area has slowed further. Inflation has been easing in most economies, as supply bottlenecks resolve and weaker demand relieves price pressures. However, with underlying inflation persisting, central banks continue to be vigilant. Oil prices are higher than was assumed in July, and the war in Israel and Gaza is a new source of geopolitical uncertainty.

In Canada, there is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures. Consumption has been subdued, with softer demand for housing, durable goods and many services. Weaker demand and higher borrowing costs are weighing on business investment. The surge in Canada’s population is easing labour market pressures in some sectors while adding to housing demand and consumption. In the labour market, recent job gains have been below labour force growth and job vacancies have continued to ease. However, the labour market remains on the tight side and wage pressures persist. Overall, a range of indicators suggest that supply and demand in the economy are now approaching balance.

After averaging 1% over the past year, economic growth is expected to continue to be weak for the next year before increasing in late 2024 and through 2025. The near-term weakness in growth reflects both the broadening impact of past increases in interest rates and slower foreign demand. The subsequent pickup is driven by household spending as well as stronger exports and business investment in response to improving foreign demand. Spending by governments contributes materially to growth over the forecast horizon. Overall, the Bank expects the Canadian economy to grow by 1.2% this year, 0.9% in 2024 and 2.5% in 2025.

CPI inflation has been volatile in recent months_2.8% in June, 4.0% in August, and 3.8% in September. Higher interest rates are moderating inflation in many goods that people buy on credit, and this is spreading to services. Food inflation is easing from very high rates. However, in addition to elevated mortgage interest costs, inflation in rent and other housing costs remains high. Near-term inflation expectations and corporate pricing behaviour are normalizing only gradually, and wages are still growing around 4% to 5%. The Bank’s preferred measures of core inflation show little downward momentum.

In the Bank’s October projection, CPI inflation is expected to average about 3.5% through the middle of next year before gradually easing to 2% in 2025. Inflation returns to target about the same time as in the July projection, but the near-term path is higher because of energy prices and ongoing persistence in core inflation.

With clearer signs that monetary policy is moderating spending and relieving price pressures, Governing Council decided to hold the policy rate at 5% and to continue to normalize the Bank’s balance sheet. However, Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed. Governing Council wants to see downward momentum in core inflation, and continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability for Canadians.