This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on March 8, 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 Friday, March 3. The Governor presided over these meetings. Members in attendance were Governor Tiff Macklem, Senior Deputy Governor Carolyn Rogers, Deputy Governor Paul Beaudry, Deputy Governor Toni Gravelle and Deputy Governor Sharon Kozicki.

The international economy

Governing Council began discussions by reviewing recent international developments. Notable developments included the following:

• Growth of gross domestic product (GDP) was slowing in all regions except in Japan.
• Global energy prices were evolving in line with the Bank’s expectations.
• Global supply chain bottlenecks were continuing to ease.
• While headline inflation rates had come down, elevated core inflation was persisting in most regions, and this had raised market expectations that interest rates may need to be higher for longer.

Governing Council noted that while global economic growth continued to slow, it had been stronger than expected in some regions, notably the United States and the euro area. In the United States, growth was being supported by exports and government spending, and consumption remained solid. Economies in the euro area were proving more resilient than expected as disruptions to the energy market resulting from Russia’s war on Ukraine had been less severe than feared.

The reopening of China’s economy had been progressing broadly in line with expectations. To this point, global oil prices remained close to the levels assumed in the January outlook. However, if Chinese demand rebounds by more than expected, global energy and other commodity prices could rise sharply, putting upward pressure on inflation around the world.

Although global growth had been slowing, labour markets were still tight, especially in the United States and Europe. Unemployment in the euro area remained at a record low. In the United States:

• unemployment was low
• the ratio of job vacancies to unemployed people was high
• wage growth was strong.

Elevated core inflation in the United States and Europe had also been persistent. In the United States, lower core goods inflation was being offset by higher inflation for core services. In the euro area, core inflation had continued to rise while headline inflation had edged down. Recent data suggest that core inflation in those regions will be stronger in the months ahead than was projected in the January Monetary Policy Report (MPR).

Members of Governing Council discussed whether the resilience of the US economy to higher interest rates and the persistence of elevated core inflation foreshadowed similar developments in Canada. Tight labour markets in Canada could lead to more persistence in core inflation here, as they are doing in the United States.

However, Governing Council members noted that there are important differences between Canada and the United States. For example, higher immigration rates and a stronger rebound in labour force participation rates in Canada, particularly among women, is helping relieve some of the pressures in labour markets. Consumption in the United States rebounded more strongly and earlier than in Canada. As well, more elevated levels of household debt and differences in the structure of the mortgage market mean that demand in Canada could be more sensitive to higher interest rates.

Governing Council discussed financial conditions, which had tightened since the January MPR. Markets expect that the US Federal Reserve will need to tighten monetary policy more, and keep it restrictive for longer, to bring US inflation back to target. Governing Council members compared their assessments of how tight financial conditions were overall, looking at a variety of indicators such as yield curves, credit spreads and equity prices. US interest rate expectations had risen across the yield curve, and the US dollar had strengthened against other currencies, including the Canadian dollar.

Canadian economic developments and the outlook for inflation

Governing Council reviewed recent domestic data and discussed how consistent recent economic developments were with the outlook in the January MPR. Overall, the economy had slowed, with clear signals that monetary policy tightening was dampening demand. The economy was flat in the fourth quarter of 2022, with real GDP growth at 0%. This was weaker than the Bank had expected, largely due to a sharp slowdown in inventory investment. Final domestic demand grew by 1% in the quarter, largely as expected, because:

• the effects of higher interest rates continued to weigh on household spending
• business investment weakened with softer domestic and foreign demand.

Governing Council members noted that slowing growth in final demand was beginning to improve the balance between demand and supply, but the economy remained in excess demand.

Members also discussed the implications of the fourth-quarter GDP data for growth in the first quarter of 2023. With inventories adjusting earlier than anticipated, Governing Council concluded that growth in early 2023 may be a bit stronger than the Bank had forecast in its January MPR.

Governing Council devoted particular attention to conditions in the labour market, where recent increases in employment had been surprisingly strong. They agreed that the labour market remained very tight and was still operating above maximum sustainable levels. While the Bank had expected to see some easing in labour market conditions, recent data suggest that the degree of tightness has not substantially changed over the past six months. Members discussed whether the increase in employment was driven by demand or supply. They also considered:

• the implications of increased population growth in 2022 compared with previous years
• how waves of the virus may have affected seasonal adjustment of the employment data
• recent shifts in the mix of employment and average hours worked.

Wage gains have remained in the range of 4% to 5%. Governing Council members agreed that the current pace of wage growth was not consistent with getting inflation back to 2% unless it were accompanied by an increase in productivity growth to well above its historical trend. While they acknowledged that productivity can be volatile and hard to measure, they noted recent data suggest productivity has actually been declining.

Inflation data are showing progress toward the Bank’s 2% target. Governing Council members looked closely at the dynamics of consumer price index inflation, which eased to 5.9% in January, slightly below the Bank’s projection. Most of that slowdown resulted from:

• lower energy prices
• continued easing in inflation for durable goods
• lower prices for some services (mainly mobile phone services).

Food price inflation continued to rise at double-digit rates. Governing Council members acknowledged that high rates of inflation in essential items, such as groceries and shelter costs, are particularly painful for low-income Canadians. Members observed that 12-month measures of core inflation had edged down to about 5%, and 3-month measures were at about 3½%. Both will need to decline further to get total inflation back to the 2% target.

Considerations for monetary policy

Members of Governing Council were comfortable with the MPR outlook that inflation will continue to ease this year as monetary policy tightening works its way through the economy and base-year effects pull down 12-month rates of inflation. However, they remain concerned about the risk that inflation could get stuck materially above the 2% target. They discussed what needs to occur for inflation to return sustainably to target. Short-term inflation expectations need to come down, as do measures of core inflation. As well, competitive pressures need to return to normal to make businesses cautious about passing on higher input costs to final goods prices. That will require a better balance between demand and supply, so businesses worry more about losing customers if they increase prices. Unit labour costs also need to moderate, with some combination of slower wage growth and faster productivity growth. This is particularly important to ease inflation in prices for most services, which is proving sticky in the face of rising unit labour costs.

Governing Council also noted that, at 3.9%, growth in government spending in the fourth quarter was stronger than expected. They observed that sustained growth in government spending that is considerably faster than potential growth would boost domestic demand. The Bank will incorporate announced fiscal plans by federal and provincial governments into its updated projection in the next MPR on April 12.

Other risks that Governing Council members discussed were those highlighted in the January MPR.

On the upside, short-term inflation expectations are higher than in the Bank’s own inflation forecast. If they do not come down, high inflation will be stickier than expected. Households could also spend more of their accumulated savings, which would boost consumption growth and contribute to demand.

On the downside, durable goods prices could fall if businesses find themselves overstocked. As well, household spending may be more sensitive to higher interest rates than the Bank has estimated because of elevated levels of household debt.

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

The policy decision

Governing Council members agreed that, taken together, economic data and developments since the January MPR did not materially change the Bank’s most recent outlook: the economy is slowing, and inflation is coming down. In this context, Governing Council agreed to maintain the target for the overnight rate at 4½%, which is consistent with the conditional pause that had been signalled in January. Members also reviewed the Bank’s quantitative tightening program and agreed to continue the current policy of shrinking the balance sheet by allowing maturing bonds to roll off.

After increasing the policy rate at each of the last eight decisions, Governing Council saw the pause as an opportunity to learn whether interest rates had increased enough to return inflation to the 2% target. They acknowledged that the Bank has put a great deal of tightening in place in a very short period and will need a further accumulation of data over time to see whether the expected impact on inflation and growth materializes along the lines of the January outlook. They agreed they would be looking for evidence that monetary policy was sufficiently restrictive to achieve the inflation objective. Governing Council members underlined that, as they continue to assess the stance of monetary policy, they must be forward-looking and focused on the likely path for inflation. If accumulated evidence were to suggest more persistence in inflation, the policy rate would need to rise further to keep inflation on a path back to 2%.

Governing Council agreed that the forward-looking communication on monetary policy should be similar to the language used in the press release dated January 23, 2023. They wanted the press release to convey that they continue to assess whether monetary policy is sufficiently restrictive. Members agreed that it was important to emphasize the conditionality of the pause, and that they remain prepared to increase the policy rate further if needed to return the inflation rate to the 2% target.