Bank of Canada signals increase soon, key interest rate remains unchanged

Authors Julie Gordon and David Ljunggren

OTTAWA (Reuters) – The Bank of Canada will soon start raising interest rates from record lows to fight inflation, Governor Tiff Macklem announced on Wednesday, saying the economy no longer needs help to cope with the effects of the COVID-19 pandemic.

Macklem spoke after the central bank surprised some analysts by leaving rates unchanged at 0.25%, although she said the economic downturn was fully absorbed and inflation would be higher for longer. Rates have been at record lows since March 2020, when the bank cut its borrowing cost three times.

“The message is pretty clear. We’re on the rise,” Macklem told reporters.

“How far and how fast? These are the decisions we will make at each meeting, depending on economic developments, depending on our inflation outlook and what we deem necessary to get inflation back on target.”

He later said several increases would be needed, but the bank could take a few steps and then pause to assess progress. The next announcement of the course is on March 2nd.

(Graph: inflation and interest rates in Canada, https://graphics.reuters.com/CANADA-CENBANK/RATES/lgvdwjrgkpo/chart.png)

“Because we’re being clear and thoughtful, we’re really trying to reduce noise so that monetary policy is more a source of confidence rather than another source of uncertainty,” Macklem said.

Still, the decision to withhold may have been a “politically wrong move,” given the current background of inflation and rising real estate prices, said Simon Harvey, head of FX analysis for Monex Europe and Monex Canada.

“Their decision to sit on the fence today could force them to take a steeper hiking trail later in the year,” Harvey said.

But others saw nothing wrong with waiting another five weeks to move, saying it would be worse to raise rates without first removing the obligation to keep them at record lows until the stalemate is lifted.

“They don’t question the credibility of the guidelines ahead for the next time they have to use them, because we know there will be them next time,” said Jimmy Jean, chief economist at Desjardins Group.

Following the decision, money markets set prices from a roughly 90% chance that the central bank would rise to 0.50% in March, with at least five increases in total this year. In recent days, the market has risen six times.

The Bank of Canada said inflation will remain close to 5% in the first half of 2022, before falling to about 3% by the end of the year. In October, the central bank said it expects inflation to return to around the 2% target by the end of 2022.

Canada’s inflation rate in December reached 4.8%, the highest level since September 1991 and for the ninth month in a row was above the Bank of Canada’s control range of 1% -3%. Inflation has not been this high since the central bank set it in 1991.

The Canadian dollar traded 0.3% higher at 1.2593 per dollar, or 79.41 U.S. cents after the rate decision, after returning some of its earlier gains.