This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on April 12, 2023.

This summary reflects discussions and deliberations by members of Governing Council in stage three of the Bank’s monetary policy decision-making process. This stage takes place after members have received all staff briefings and recommendations.

Governing Council’s policy decision-making meetings began on Tuesday,  April 4. The Governor presided over these meetings. Members in attendance were Governor Tiff Macklem, Senior Deputy Governor Carolyn Rogers, and Deputy Governors Paul Beaudry, Toni Gravelle, Sharon Kozicki and Nicolas Vincent.

The international economy

Governing Council began discussions by reviewing recent international developments, notably:

• signs of greater strength in Europe and the United States
• the continued juxtaposition of declining headline inflation with increasing momentum in core inflation in both Europe and the United States
• the recent banking sector stress in the United States and Europe and its implications for the global outlook
• the evolution of oil prices

Governing Council noted that while global economic growth remained subdued, it was again coming in stronger than expected, particularly in the euro area and the United States. In the United States, goods consumption in the first two months of 2023 was surprisingly robust, supported by ongoing strength in disposable income. Despite the severe economic effects of Russia’s war in Ukraine, the euro area economy proved to be more resilient than expected, partly reflecting less severe winter weather and new non-Russian energy supplies. Unemployment remained low, and the improved outlook for the supply of energy boosted consumer and business confidence.

Momentum in core inflation in the euro area and the United States rose in the first two months of 2023. Governing Council agreed that while restrictive monetary policy is expected to bring inflation down, the persistence of high core and services inflation could make restoring price stability more difficult than anticipated.

Governing Council discussed the episodes of banking sector stress in the United States and Europe caused by deposit runs at some regional US banks and, soon after, the collapse of Credit Suisse. Governing Council agreed that rapid and decisive action by relevant authorities had limited contagion to other financial institutions. Even so, credit conditions had tightened further, and the potential for additional stress had increased overall uncertainty. Governing Council debated how developments in the global financial system might evolve.

Members of Governing Council agreed that their base case was for continued stability in the global financial system, but with higher bank funding costs that would result in tighter credit conditions. This, in turn, would have a dampening effect on global economic growth and ultimately inflation.

The downside case would see a re-emergence of acute and more persistent stresses, potentially spreading to other parts of the financial system and to other jurisdictions. In this case, global credit conditions could tighten significantly, resulting in a much more severe global slowdown. Liquidity events could also occur, which could make it necessary for central banks to deploy their tools to maintain effective core market functioning.

Governing Council reviewed commodity price developments, notably the evolution of oil prices over the past month. Oil prices had fallen significantly in the wake of heightened stress in the global financial system but had since rebounded as stress abated. In addition, several members of the Organization of the Petroleum Exporting Countries (OPEC) and some non-OPEC oil producers announced surprise voluntary cuts in oil production for May to December 2023, boosting prices further. Despite this volatility, the Bank’s assumptions for oil prices ended up unchanged from the January Report.

Canadian economic developments and the outlook for inflation

Governing Council assessed recent data and developments in Canada and judged them to be evolving broadly in line with their January projection. Headline inflation was coming down, and signs of a rebalancing of supply and demand were becoming evident. But Governing Council acknowledged that the labour market was still tight and the slowing in growth would likely come a little later. In general, Governing Council agreed that while the new economic projection was similar to January’s, there was a sense that the economy was proving a little stronger than expected.

On the labour market front, indicators continued to show overall tightness:

• While job vacancies had begun to ease, they remained high.
• Hiring continued to be robust.
• The unemployment rate remained near record lows.
• Wage growth was in the 4% to 5% range.

Members of Governing Council revisited their concern that the current pace of wage growth, if sustained, would not be consistent with getting inflation back to 2% without a substantial increase in productivity (which has been declining in recent quarters). Members also discussed the results of the most recent Business Outlook Survey, in which companies indicated that although the labour market was still tight, labour market pressures were beginning to ease. Businesses viewed current labour shortages as less intense than a year ago and were finding it somewhat easier to fill vacancies.

Governing Council spent considerable time discussing the implications of rapid population growth for the interpretation of recent data and the forecast. The Canadian population grew by about 1 million people in 2022, driven by large inflows of new permanent and non-permanent residents. Governing Council members acknowledged that while this was helping to alleviate labour pressures, it added to demand as well as supply, given that newcomers to Canada are also consumers.

In this context, the strong hiring numbers in the Labour Force Survey in recent months were perhaps not surprising. With faster population growth, employment growth could be stronger than the historical trend without adding to labour market tightness.

Governing Council discussed how it would be important to account for the fact that aggregate consumption is being pushed up by overall population growth, whereas per capita consumption is weakening, reflecting the restraining effects of tighter monetary policy. Governing Council agreed that, overall, consumer spending is anticipated to be subdued in the second half of 2023 and into 2024 as the effects of the tightening in monetary policy work their way through the economy.

Governing Council also discussed the implications for government spending of recent federal and provincial budgets. Overall spending was higher than the Bank had previously projected, and this would add to the growth in gross domestic product over the next couple of years. With the growth in government spending anticipated to be broadly in line with the growth in potential output, federal and provincial fiscal plans were not expected to contribute to the reduction in inflationary pressures. At the same time, given that growth in government spending was not running materially ahead of potential growth, it was not adding significantly to inflationary pressures either. Governing Council noted the advice from the International Monetary Fund that it was important that new spending measures aimed at alleviating the burden of high inflation be targeted and temporary.

Governing Council agreed that the effects of recent global banking stress had been muted in Canada. Canadian banks have seen only a modest increase in funding costs, and credit conditions have tightened slightly. The more important impact is that tightening credit conditions in the United States will likely slow US business spending, with implications for Canadian exports.

The housing market in Canada continued to be subdued because restrictive monetary policy was raising mortgage servicing costs substantially. While the near-term outlook was for the housing market to moderate further, population growth will support underlying demand for housing.

Governing Council noted that total consumer price index inflation, which was 5.2% in February, was coming down in line with the Bank’s expectations. All members agreed that barring any new shocks, it was likely to reach 3% by this summer. This is because past declines in energy prices, easing supply chain bottlenecks and restrictive monetary policy were all being reflected in decreasing goods price inflation.

Members observed that the Bank’s preferred 12-month measures of core inflation had continued to edge down to under 5%, and 3-month measures remained at about 3.5%. Core services price inflation in Canada was still higher than overall inflation and showing persistence. Food price inflation continued to rise at double-digit rates. High rates of inflation in essential items, such as groceries and shelter, are particularly painful for low-income Canadians.

Considerations for monetary policy

Governing Council members turned to the Bank’s new outlook for growth and inflation and agreed it could be appropriately characterized as largely in line with the January outlook. That said, while Governing Council was more confident that inflation in Canada would continue to fall in the coming months to around 3%, the second stage of disinflation all the way back to 2% could prove more difficult. Governing Council remained concerned that:

• Consumer demand in Canada could prove more robust.
• Growth in government spending could be stronger than forecast, boosting domestic demand.
• Elevated services price inflation in Canada could be more persistent, particularly if the labour market remained tight and productivity weak.
• Energy prices could rise if there were further shocks to supply or greater global demand.
• Near-term inflation expectations could stay higher for longer.
• Corporate pricing behaviour might take longer to normalize.

On the other side, Governing Council agreed that restrictive monetary policy has been working and its effects would continue to broaden. In particular, members discussed the effect that the rapid tightening of monetary policy was going to have on some homeowners. Given the prevalence of five-year fixed-rate mortgages in Canada, most mortgage holders could be expected to renew at much higher rates over the next few years. Other things being equal, this would increase their mortgage payments, leaving less disposable income for discretionary spending.

Governing Council continued to be more concerned about upside risks to the projection, given that inflation remains above target.

The policy decision

Taking into account recent global and Canadian economic developments, the expected near-term path for inflation and the updated outlook, including risks around it, Governing Council debated appropriate policy approaches to ensure inflation returns sustainably to target.

The immediate decision focused on whether to increase the policy rate or hold it at 4½%. As part of this discussion, Governing Council also considered how long the policy rate would need to remain elevated in order to return inflation to target.

The discussion around increasing the interest rate further focused on whether monetary policy was restrictive enough and whether it was best to raise the policy rate now or wait for more evidence. The main arguments for moving up sooner rather than later were:

• the resilience of economic growth and the persistence of elevated core inflation to date
• concern that the evolution of inflation from 3% to 2% through the second half of 2023 and 2024 could prove more difficult
• the need to be forward looking and not wait too long to ensure that monetary policy was restrictive enough

The case to maintain the policy rate at 4½% reflected Governing Council’s view that headline inflation is coming down quickly in line with the Bank’s forecast and that more evidence would be needed to assess whether monetary policy was sufficiently restrictive. The key arguments supporting this approach were:

• The outlook for growth and inflation in Canada was broadly unchanged.
• There were indications that pressures on demand, inflation and labour markets were likely to ease in the quarters to come.
• Governing Council should use the opportunity to accumulate more evidence that a higher policy rate is in fact required.

Governing Council discussed the possibility that monetary policy may need to be restrictive for longer. In this regard, Governing Council reflected on market expectations that the policy rate will be lowered as early as the second half of this year. Council members discussed possible rationales to explain market pricing. One rationale is that markets continue to price in a probability of a severe economic contraction and a sharp drop in interest rates. Another is that markets expect that policy rates will naturally ease back as inflation softens and supply and demand return to balance.

Governing Council members agreed that while a risk of a sharper slowdown remains, based on their current outlook, cutting rates later this year did not seem to be the most likely scenario.

Governing Council agreed at this decision to maintain the target for the overnight rate at 4½% and continue to assess whether monetary policy is sufficiently restrictive to return inflation to the 2% target. Members also reviewed the Bank’s quantitative tightening program and agreed to continue the current policy of normalizing the balance sheet by allowing maturing bonds to roll off.

With the current decision taken, Governing Council agreed that the forward-looking communication on monetary policy should be broadly unchanged. In particular, Governing Council agreed that it was important to continue to signal that it was prepared to increase the policy rate further if needed.