The Bank of Canada maintained its overnight rate at 4.5 per cent this morning. In the statement accompanying the decision the Bank noted that demand in Canada still exceeds supply and labour markets remain tight and that first quarter economic growth looks stronger than expected. However, the bank expects consumption growth to slow this year as households renew mortgages at higher rates and growth in exports and investment will decline as the US economy slows substantially in coming months. On inflation, the Bank expects headline CPI inflation to fall to 3 per cent in the middle of this year before declining gradually to 2 per cent by the end of 2024. However, the Bank warned getting inflation back to 2 per cent will be challenging given still high inflation expectations, elevated service sector prices and strong wage growth.
The Bank of Canada has moved to the sidelines while it judges the past year's impact of rate increases on inflation. Several factors point to inflation beginning to normalize this year. Barring a significant shift, gas prices are starting to subtract from year-over-year CPI inflation and raw materials and shipping costs should benefit from a downtrend in global commodity prices and a normalization of supply chains. The open question for the economy remains whether a recession is likely to occur this year. Given the pace and magnitude of tightening by the Bank of Canada, and signals from traditional recession warning tools like the slope of the yield curve, the recession probability remains elevated, particularly given added uncertainty stemming from failures in the US banking sector. However, growth has remained firmer than expected and the economy continues to create jobs at a robust pace. Still, high interest rates will start to drag on the broader economy this year and slower growth and significant progress on inflation should keep the Bank sidelined with the possibility of a rate cut in early 2024.
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