Breaking News: Bank of Canada Raises Interest Rates to 5% Amidst Global Economic Shifts

The Bank of Canada announced an increase in its target for the overnight rate to 5%, accompanied by the Bank Rate at 5¼% and the deposit rate at 5%. The central bank also stated its commitment to quantitative tightening. While global inflation has been easing due to lower energy prices and a decline in goods price inflation, persistent inflationary pressures in services persist due to robust demand and tight labor markets. The United States has experienced stronger-than-expected economic growth, with resilient consumer and business spending. Conversely, China's economic growth has softened with slowing exports and ongoing weakness in its property sector, while growth in the euro area has effectively stalled, primarily due to contracting manufacturing. Global financial conditions have tightened, with increased bond yields in North America and Europe as major central banks indicate the need for further interest rate increases to combat inflation.

Canada's economy has shown greater strength than anticipated, with momentum in demand and surprisingly strong consumption growth of 5.8% in the first quarter. Although the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent data suggests persistent excess demand in the economy. The housing market has also seen some pickup, with demand outpacing new construction and real estate listings, leading to increased pressure on prices. While there are signs of increased worker availability in the labor market, conditions remain tight, and wage growth has been around 4-5%. Strong population growth from immigration has added both demand and supply to the economy, easing the shortage of workers while boosting consumer spending and housing demand.

As higher interest rates continue to have an impact on the economy, the Bank anticipates a slowdown in economic growth, averaging around 1% in the second half of this year and the first half of the next. This implies real GDP growth of 1.8% in 2023 and 1.2% in 2024. The economy is expected to experience modest excess supply early next year before growth picks up to 2.4% in 2025.

Inflation in Canada dropped to 3.4% in May, a significant decrease from its peak of 8.1% last summer. However, the downward momentum has been primarily driven by lower energy prices rather than easing underlying inflation. Core inflation rates have remained around 3½-4% since September, indicating persistent price pressures. Business surveys conducted by the Bank also suggest that companies are increasing their prices more frequently than usual.

The Bank's July Monetary Policy Report projects CPI inflation to hover around 3% for the next year before gradually declining to 2% by mid-2025. This slower return to the target of 2% inflation compared to previous projections raises concerns for the Bank, as it could hinder the achievement of price stability.

Considering the evidence of persistent excess demand and elevated core inflation, as well as the revised outlook for economic activity and inflation, the Governing Council decided to raise the policy interest rate to 5%. The Bank will continue to evaluate core inflation dynamics, inflation expectations, wage growth, and corporate pricing behavior to ensure consistency with achieving the 2% inflation target. The Bank remains committed to restoring price stability for Canadians through its monetary policy and quantitative tightening measures.