This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on October 25, 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, October 17. The Governor presided over these meetings. Members in attendance were Governor Tiff Macklem, Senior Deputy Governor Carolyn Rogers and Deputy Governors Toni Gravelle, Sharon Kozicki, Nicolas Vincent and Rhys Mendes.

The international economy

Governing Council members began their deliberations by discussing recent global economic developments. Global growth had been moderating, and inflation had been easing across most economies, consistent with the Bank’s projection in July. However, the composition of global growth had shifted, with the US economy proving to be more resilient and China’s economy more sluggish than expected.

Members discussed potential reasons for the strength in US consumer spending and economic growth. The drawdown in savings accumulated during the pandemic was much larger in the United States than in Canada. Strong income growth was also supporting consumption in the United States. Meanwhile, US productivity growth was strong, and growth in unit labour costs was moderating, helping to ease core inflation. Inflation in the United States was expected to ease further as higher policy interest rates and tighter financial conditions slowed demand.

In China, foreign direct investment had dropped considerably, and the problems in its property sector continued to weigh on confidence and economic growth. Members noted that the rebound in transportation and travel may have masked some of the underlying weakness in the economy. Members also noted a high level of uncertainty around the outlook for China.

In the euro area, growth was easing as expected while tighter monetary policy gained traction. Inflation had been declining as anticipated, but members were less sure of further progress, given the uncertain outlook for energy prices.

The October projection assumed oil prices were $10 higher than in July. The war in Israel and Gaza increases the risk that oil prices could remain high or rise further.

Governing Council spent a considerable amount of time discussing global financial conditions, given the recent rise in global bond yields. Members reflected on several possible explanations for this rise, including:

• market assessments that central bank policy rates would remain higher for longer
• a rise in the term premium stemming from higher uncertainty as investors sought greater compensation for volatility in long-term rates
• continued deficit financing in the United States leading to a large supply of US Treasuries together with fewer buyers and quantitative tightening
• the possibility that the neutral rate might be drifting higher

It was difficult to be sure which of these factors were having the greatest impact. Members also observed that equity markets had largely held up despite the rise in yields due to continued strong earnings reports and strength in technology stocks related to artificial intelligence.

The Canadian economy and inflation outlook

Governing Council reviewed the developments in the Canadian economy and the dynamics of inflation since July. Canada’s economic growth had slowed over the past year, averaging about 1%. Members agreed signs were clearer that monetary policy was working to dampen spending. With demand slowing and supply catching up, the economy was approaching balance.

Consumer spending was weaker than expected. Members noted that household credit growth had declined substantially as households adjusted to higher borrowing costs. Responses to the Canadian Survey of Consumer Expectations for the third quarter pointed to more weakness in spending on housing and durable goods, and members noted that weaker spending had begun to spread to services.

Exports were expected to stall as foreign demand softened. And businesses responding to the Business Outlook Survey for the third quarter reported softer investment intentions due to elevated funding costs and weaker sales prospects.

Governing Council members discussed the aggregate spending plans of federal and provincial governments, which are projected to increase at an annual pace of roughly 2.5% in 2024. If all those plans are realized, this would contribute materially to growth over the next year. By adding to demand at a faster pace than the growth of supply, government spending could get in the way of returning inflation to target.

On the labour market, Governing Council agreed that a wide range of indicators pointed to continued easing. But overall, the labour market still looked to be on the tight side:

• The pace of job creation had slowed to below that of labour force growth.
• Businesses reported widespread easing in the intensity of labour shortages.
• Job vacancies had declined gradually but were still above pre-pandemic levels.
• The unemployment rate had risen slightly but was low by historical standards.
• Wages continued to grow in a range of between 4% and 5%.

Members observed that the pace of recent wage growth partially reflected a catch-up in real wages. Some businesses reported plans to continue raising salaries to retain workers. Members discussed the likelihood that chronic labour shortages could persist in sectors such as health care and skilled trades, even as the overall tightness in the labour market continued to recede.

Governing Council reviewed recent data on inflation. While consumer price index inflation had declined from a peak of 8.1% since June 2022, recent inflation data had been volatile: 2.8% in June 2023, 4% in August and 3.8% in September. Nevertheless, members agreed that the effects of higher interest rates were increasingly reflected in the prices of many goods that people buy on credit, such as furniture and appliances.

Progress in reducing inflation is also evident in the prices of many semi-durable goods and services excluding shelter. Along with durable goods, these components grew at 2% or less in September. Inflation in services excluding shelter was below its historical contribution to inflation overall, but there had been some unusual volatility in certain services prices. Food price inflation eased as well but remained elevated at close to 6%. Members agreed that food price inflation should moderate further as lower input costs are passed along to final food prices.

Despite this progress, members revised up their near-term outlook for inflation. Members discussed several factors that had been standing in the way of the disinflationary process:  

• Higher global oil prices had pushed up gasoline prices. This was the main factor behind the rebound in inflation since June.
• Shelter price inflation was running around 6%. This was partly due to rising mortgage interest costs following increases in the policy interest rate. But high shelter price inflation was also evident in rent and other housing-related costs. Higher interest rates would normally exert downward pressure on house prices and other costs that are closely linked to house prices, such as maintenance, taxes and insurance. However, the ongoing structural shortage of housing supply in the economy was sustaining elevated house prices. And the rapid increase in Canada’s population had added to the existing imbalance between demand and supply for housing.
• Near-term inflation expectations and wage growth remained elevated.
• Corporate pricing behaviour was normalizing only gradually.

Together, these factors were contributing to persistence in inflation. Measured on a three-month annualized basis, core inflation had been stuck in a range of 3.5% to 4% for the past year, suggesting little downward momentum in underlying inflation.

As a result, Governing Council members revised up their forecast for inflation in the near term. But with a weaker growth outlook and more excess supply, they continued to expect inflation would return to the 2% target in 2025.

Considerations for monetary policy

Governing Council members reflected on how recent economic developments could affect monetary policy. They revisited their discussion in September, when they decided to maintain the policy rate at 5%. At that time, the data received since July had shown more clearly that demand was slowing as monetary policy worked its way through the economy.

At the October meetings, members agreed that the evidence demonstrated further progress toward rebalancing the economy. Monetary policy continued to gain traction—excess demand was being absorbed, and price pressures were easing for many goods and services.

However, members acknowledged that the translation of weaker demand into lower price growth had been slow. The lack of downward momentum in underlying inflation was a source of considerable concern. They reflected again on the two possible explanations for this persistence: that the transmission of monetary policy actions through to inflation required more time, or that monetary policy was not yet restrictive enough to relieve price pressures.

Members discussed whether the stickiness in core inflation measures reflected the fact that excess demand remained in the system or that inflation could be becoming entrenched.

While the output gap indicated the economy was entering a period of excess supply, considerable uncertainty surrounds this estimate. Latent excess demand could explain why:

• the labour market remained on the tight side
• businesses continued to raise prices more often than normal
• near-term inflation expectations remained elevated

Wage growth, if sustained at the current pace of 4% to 5%, would be inconsistent with restoring price stability. Members agreed they would be watching closely to see if higher labour costs began to be reflected in renewed inflationary pressures.

On corporate pricing behaviour, despite some progress toward normalization, many businesses were still reporting that they would raise prices more frequently than normal. Members expressed concern that businesses would:

• be slower to pass on price decreases as input costs decline
• increase their prices more rapidly in response to future shocks

Finally, members noted that while near-term inflation expectations remained elevated, they had been easing. Long-term inflation expectations remained well anchored. Thus, current household spending and business decisions more likely reflected recent experiences with inflation rather than an acceptance that high inflation was here to stay.

As excess demand continues to be absorbed, persistence in core inflation, elevated inflation expectations and wage growth, and atypical corporate pricing behaviour could be indications of high inflation becoming entrenched. In such a scenario, members acknowledged that further monetary policy tightening would likely be required to restore price stability.

Members also discussed the implications of elevated shelter price inflation for monetary policy. Given that increasing the supply of housing enough to substantially narrow the shortfall will take time, shelter price inflation could continue to contribute more than normal to overall inflation for some time.

Finally, Governing Council also discussed the risk that the economy could slow more than expected. The outlook for GDP had been revised down from the July MPR, in part due to tighter financial conditions globally. If global financial conditions tighten further or past increases in the policy interest rate restrain demand more than expected, the economy could be weaker and inflation lower than projected.

Overall, Governing Council members agreed that monetary policy was working to lower demand and ease price pressures for many goods and services. They also agreed that as the economy moved into excess supply, past monetary policy tightening should continue to translate into lower inflation. However, with a higher near-term forecast for inflation and persistent core inflation, as well as the risk that rising global tensions could lead to higher oil prices or renewed supply chain disruptions, they agreed that overall inflationary risks had increased.

The policy decision

Governing Council discussed whether monetary policy was sufficiently restrictive to return inflation to target.

Some members felt that it was more likely than not that the policy rate would need to increase further to return inflation to target. Others viewed the most likely scenario as one where a 5% policy rate would be sufficient to get inflation back to the 2% target, provided it was maintained at that level for long enough.

However, there was a strong consensus that, with clearer evidence of higher interest rates moderating spending, slowing growth and relieving price pressures, Governing Council should be patient and hold the policy rate at 5%. They agreed to revisit the need for a higher policy rate at future decisions with the benefit of more information.

Given the slower-than-expected progress toward price stability and increased inflationary risks, members agreed to state clearly that they were prepared to raise the policy rate further if needed.

Members noted that they needed to see downward momentum in core inflation to be confident that monetary policy was sufficiently restrictive to restore price stability. They agreed to continue to assess the evolution of underlying inflationary pressures by focusing on the following indicators:

• the balance between demand and supply in the economy
• inflation expectations
• wage growth
• corporate pricing behaviour

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.