After a string of stronger than expected economic data and firm inflation readings, the Bank of Canada ended its rate pause and hiked its policy rate by 25 basis points on June 7. This lifted the target for the overnight rate to 4.75%. Market expectations were relatively split on whether the Bank would hike or wait until July.
There are some economists who argue that the Bank should have held off raising rates. Ambler and Kronick note that much of the increase in inflation came from a 6.3% increase in gasoline prices from March to April. They also note that the decline in money supply is indicative of an easing in inflation – cash and chequing accounts are declining, and savings accounts are growing slowly. When inflation is unanchored from its target, money growth becomes a good predictor of where prices are headed.
Ambler and Kronick’s view is that “a one-month reversal in the downward path of headline inflation does not make a new trend, and the balance of evidence supported a wait-and-see approach. If the hike was, indeed, overkill, the long-hoped-for decline in the overnight rate will happen sooner rather than later.”
Monetary policy works with a lag. The challenge for the central bank is knowing when to stop. Perhaps additional data will suggest that further action is not required. The Bank of Canada and most private sector economists have predicted that GDP will stall through the middle of 2023.
There are also signs labour market tightness may be loosening. Just as the Bank moved to tighten to curb excess demand in the economy, the Canadian labour market showed signs of slowing. Employment fell by 17,300 (0.1%) in May, and while a small change, the loss was driven by full-time employment. Hours worked fell 0.4%, which was the largest decline in the past 12 months. The unemployment rate rose 0.2% to 5.2% – the highest level since October – which was driven in part by a rise in both the working age population and labour supply from immigration.
Average wage growth slowed to 5.1% year-over-year, down from 5.2% in April and 5.3% in March. The large-province trends are weak (ON, QC, BC), with Ontario showing a downturn in most services. Full-time employment gains have weakened in most provinces in the last three months.
In addition to raising the overnight rate, the Bank of Canada has been conducting quantitative tightening, which increases the cost of borrowing. (Quantitative tightening is a policy tool used by central banks to decrease the amount of money or liquidity in the economy.) Blackrock suggests that when quantitative tightening in the U.S. is factored into the overall stance of monetary policy, U.S. “monetary policy [is] the most restrictive it’s been since the 1980s.” A similar comment could be made for Canadian monetary policy.
The Bank will have another CPI release and labour market report before its July rate decision. Will that data be sufficient for the delicate balance between demonstrating its commitment to bringing inflation back to target and assessing whether its hikes are now sufficient to attain this goal? Right now, it is unclear whether we could face another rate increase this summer.
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