Bank of Canada keeps borrowing costs unchanged

The Bank of Canada kept borrowing costs unchanged, but highlighted strength in the labor market and worries about the persistence of inflation that will likely keep expectations of imminent interest rate hikes intact.

In a statement-only decision Wednesday, policy makers led by Governor Tiff Macklem left the benchmark overnight rate unchanged at 0.25% and reiterated the economy continues to require considerable monetary policy support.

Still, officials dropped a reference to inflationary pressures being temporary and noted recent job gains have been broad-based, with the employment rate returning to pre-pandemic levels.

While the language changes from the previous decision were incremental, there’s nothing in the statement that’s likely to derail investor expectations that the Bank of Canada is about to embark on an aggressive campaign of rate hikes.

“Inflation is elevated and the impact of global supply constraints is feeding through to a broader range of goods prices,” according to the statement, which added that “recent economic indicators suggest the economy had considerable momentum into the fourth quarter.”

The Bank of Canada is at the forefront among Group of Seven central banks in slowing its stimulus efforts.

In October, it ended its bond-buying stimulus program and accelerated the potential timing of future rate increases amid worries that supply disruptions are driving up inflation. Markets are pricing in rate hikes in Canada next year at a faster pace than the Federal Reserve, which has yet to end its quantitative easing program.

Before Wednesday, investors were pricing in five Canadian increases next year, with a more than 50% chance of a first hike by January. The stand-pat decision was expected by all 22 economists surveyed by Bloomberg News. Markets had put the chances of a hike this week at about a 20%.

Canadian yields at the front-end of the curve fell on the news, with two-year yields sliding about five basis points to 1.09%. The loonie briefly reversed earlier gains before recovering some ground to trade close to where it was before decision.

At least one rate hike by the Bank of Canada’s March 2 decision is fully priced in. Some analysts had speculated the central bank would strongly hint at a rate hike at its next decision in late January, which didn’t materialize. That prompted investors to pare back bets on a hike next month.

The decision was “slightly hawkish, but non-committal,” Simon Harvey, senior FX market analyst at Monex Europe Ltd., said by email.

Yet, it’s become increasingly difficult for the central bank to keep ultra accommodative policy in place.

A report due next week from Statistics Canada may show inflation hitting a three-decade high in November of about 5%. The unemployment rate is near five-decade lows. Employers are struggling to fill positions, and wage pressures are mounting. Home prices, meanwhile, have soared.

In the statement, policy makers cited all of these developments in their assessment of the Canadian economy.

Constraining the central bank’s ability to move is a commitment not to increase interest rates until the recovery is complete — something officials projected in October wouldn’t happen until the “middle quarters” of 2022. That means April at the earliest, though new projections will be released in January that could give the central bank more scope to move earlier.

Macklem has also pledged not to sell down the central bank’s holdings of Canadian government bonds until at least the rate hiking cycle has started.

In their assessment of the the global economy, the central bank on Wednesday said it continues to see activity recover, with inflation increasing in many countries as strong demand comes up against supply disruptions. The omicron variant, though, has “injected renewed uncertainty” to the global economic picture.

The emergence of the omicron variant, along with recent floods in British Columbia, could also “weigh on growth.”

There were some nuanced changes around the language on inflation, however. The central bank said the effects of global supply constraints will “likely take some time to work their way through, given existing supply backlogs.” They said they continue to expect inflation to remain elevated in the first half of 2022, before easing back toward 2% in the second half of the year.

“The bank is closely watching inflation expectations and labor costs to ensure that the forces pushing up prices do not become embedded in ongoing inflation,” officials said. A similar sentence in the October statement described these forces as temporary.