Bank of Canada holds rates, says inflationary risks have increased

By Steve Scherer and David Ljunggren

OTTAWA (Reuters) -The Bank of Canada (BoC) on Wednesday held its key overnight rate at a 22-year high of 5.0% as expected but left the door open to more hikes, saying price risks were on the rise and inflation could exceed its target for another two years.

The bank increased rates 10 times between March 2022 and this July, with inflation peaking at more than 8% last year. Inflation in September dipped to 3.8% from 4.0% in August, and the central bank said it would average 3.5% through mid-2024.

Inflation is expected to return to the 2% target by the end of 2025, slightly later than July’s forecast of mid-2025, “but the near-term path is higher because of energy prices and ongoing persistence in core inflation,” the BoC said.

Inflation will decline to around 2.5% in the second half of 2024, the bank said, reiterating that it is still prepared to raise rates further if needed.

“Progress towards prices stability is slow and inflationary risks have increased,” the BoC said in a statement.

Among the risks cited were oil prices, which are higher than had been assumed in July, and the war in Israel and Gaza, which adds to geopolitical uncertainty, the BoC said.

“The Bank of Canada delivered a hawkish hold as expected, but it was slightly more hawkish than I had expected going into it,” said Derek Holt, head of capital markets economics at Scotiabank.

Wages continued to grow between 4% and 5% annually and core inflation measures have shown “little downward momentum,” the bank said.

But the bank also struck a dovish note. It slashed growth forecasts and BoC Governor Tiff Macklem said the path to avoiding a recession has narrowed.

Gross domestic product is seen rising at an annualized rate of 0.8% in both the third and fourth quarters of 2023. The BoC in July forecast third-quarter annualized growth of 1.5%.

“There is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures,” the BoC said. “A range of indicators suggest that supply and demand in the economy are now approaching balance.”

The BoC cut its 2023 growth estimate to 1.2% from 1.8% in July and said 2024 growth would be 0.9%, down from a previously forecast 1.2%. The global economy is slowing and a recent surge in global bond yields is weighing on demand, the bank said.

“The path to a soft landing is narrow, and in this projection, that path has gotten narrower,” Macklem said.

The Canadian dollar weakened to a seven-month low at 1.3810 per U.S. dollar, or 72.41 U.S. cents, down as much as 0.5% on the day.

“Although the Bank of Canada maintained its tightening bias today, the rest of its communications suggest that the Bank is growing more confident it has done enough to eventually get inflation back to 2%,” said Stephen Brown, deputy chief North America economist at Capital Economics.

“We continue to expect the bank to cut interest rates by much more than markets are pricing in next year,” Brown said.

Money markets now price in a 15% chance of a rate hike in December, and they see only a slight chance of interest rates easing starting in July 2024.

The central bank is probably done raising rates and will hold them at 5.0% for at least six months, according to a Reuters poll of economists published on Friday.

(Reporting by Steve Scherer and David Ljunggren; Additional reporting by Ismail Shakil in Ottawa and Nivedita Balu and Fergal Smith in Toronto; Editing by Mark Porter)