The Bank of Canada left its benchmark interest rate unchanged at 4.5 per cent and released updated forecasts that suggest Canada will avoid a recession, although the economy’s unexpected strength — the result of pent-up demand for services and a surge in government spending — is complicating policymakers’ efforts to get inflation back to their target of two per cent.

We apologize, but this video has failed to load.

Try refreshing your browser, or
tap here to see other videos from our team.

Bank of Canada holds interest rate, but get ready for higher for longer Back to video

We apologize, but this video has failed to load.

Try refreshing your browser, or
tap here to see other videos from our team.

Play Video

“Getting inflation the rest of the way back to (two per cent) could prove to be more difficult because inflation expectations are coming down slowly, service price inflation and wage growth remain elevated, and corporate price behaviour has yet to normalize,” the Bank of Canada said in its policy statement released April 12.

“Governing Council continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the (two per cent) target.”

In other words, prepare for interest rates that are high — or higher — for longer.

Here’s what you need to know:

Surprises

Prices of financial assets tied to short-term interest rates suggest some investors are preparing for cuts by the end of the year. There’s no hint of any of that in the Bank of Canada’s forecast or guidance. The forecast shows the economy is stronger than policymakers were expecting, suggesting the central bank might yet achieve a “soft landing” from elevated levels of inflation and unsustainably fast growth.

But that forecast also shows that getting inflation all the way back to the inflation target — which governor Tiff Macklem has said he intends to do, no matter what — could require a difficult push at the end. The outlook has year-over-year increases in the consumer price index slowing to about three per cent by the second half of 2023, but getting hung up at 2.5 per cent at the end of year.

If that’s how things unfold, it’s hard to imagine interest rate cuts will be on the table before sometime in 2024. Macklem used his opening statement at his quarterly press conference — an important communications vehicle that the Bank of Canada uses to amplify its messages and add context to its thinking — to emphasize that he and his deputies “discussed whether we’ve raised rates enough” to get inflation back to the target.

There was no mention of cutting interest rates. “That doesn’t look like the most likely scenario to us,” he said of market expectations that economic conditions will force the Bank of Canada to cut borrowing costs.

Inflation

The Bank of Canada has been slicing the price data to get a read on the sources of inflation. The good news: when measured as a three-month moving average, inflation has slowed to about 1.6 per cent, suggesting price pressures are receding. Additional good news: the central bank ran some calculations that suggest grocery prices are about to drop, assuming recent historical patterns still apply.

The bad news: the cost of services isn’t falling, probably because there is still lots of pent-up demand from people denied travel and restaurants during the pandemic, and providers of such services are struggling to find workers. The Bank of Canada reckons “core” services inflation, excluding costs associated with shelter, was still growing at an annualized pace of about six per cent, when measured on a three-month basis.

“For CPI inflation to return sustainably to the two per cent target, core inflation will need to come down further,” the central bank said in its economic update.

Wage growth is a problem

It hasn’t attracted a lot of attention, but average wages are now increasing faster than headline inflation. That shift doesn’t mean millions of people are suddenly better off, given the cost of food and shelter remains high. But at an aggregate level, it means wages are becoming a more important source of inflation.

The Bank of Canada maintains that wage increases are inflationary when they exceed productivity growth. That’s because higher incomes are adding to demand at a rate that’s faster than companies are increasing their ability to supply that demand.

“Unless a surprisingly strong pickup in productivity growth occurs, sustained (four per cent) to (five per cent) wage growth is not consistent with achieving the (two per cent) inflation target,” the report said.

The Bank of Canada’s new forecast for trend productivity growth through 2026 is about one per cent.

No recession

They said it couldn’t be done.

Many economists predicted a recession was inevitable when central banks around the world lost their grips on inflation, and responded by jacking up interest rates. Macklem and his peers acknowledged the possibility, but insisted there was a narrow path to a “soft landing.” The Bank of Canada’s forecast suggests they found it.

In Canada’s case, outsized levels of immigration appear to have provided a cushion, offsetting the impact to higher interest rates on demand. Government spending also provided a boost, perhaps even too much, as policymakers described public spending as “robust” over the second half of 2022.

“Over the projection horizon, government spending will contribute steadily to GDP growth, with the biggest contribution coming from provincial spending,” the quarterly economic outlook report said.

The term “soft landing” implies something gentle. It probably doesn’t feel like that for the thousands of people in technology and other industries that are downsizing in anticipation of slower growth and more expensive capital over the next year or so. And there still could be negative quarters of GDP growth, as the Bank of Canada’s outlook has growth in the United States dropping significantly, business investment stalling for the next two years and higher mortgage rates weighing on consumption.

Growth of about one per cent is better than zero or negative, but it might not feel like it.

• Email: kcarmichael@postmedia.com | Twitter: CarmichaelKevin