Steadfast at 5% Amid Economic Dynamics
In its initial policy decision for 2024, the Bank of Canada has opted to keep the overnight rate steady at 5%, continuing a hiatus initiated after the last increase in July. As market participants eagerly await the subsequent statement and press conference, the focus lies on discerning clues about the central bank's timeline for maintaining interest rates at current levels. While expectations of an imminent shift to interest rate cuts persist, the Bank of Canada is likely to dispel such notions in its communication.
While the central bank has hinted at the possibility of an earlier-than-expected conclusion to the quantitative tightening policy, it's important to note that the primary objective remains ensuring adequate liquidity in funding markets. This is not a signal of a shift to a more accommodating monetary policy or an indication of impending rate cuts.
Economic Crossroads: Soft Developments vs. Inflationary Pressures
Economic indicators suggest that the need for further interest rate hikes is diminishing, given recent softness in economic developments. However, stubbornly persistent inflation and wage growth have dissuaded the Bank of Canada from contemplating the initiation of an easing cycle. Consumer prices experienced a year-over-year increase of 3.2% in Q4, slightly below the central bank's October projection of 3.3%. Despite this, the December inflation report revealed a re-acceleration in the closely-monitored 3-month average increase in the Bank of Canada's preferred core measures, reaching the 3.5% to 4% range, underscoring that inflation remains a concern.
Looking ahead, the prevailing trajectory for inflation appears to be downwards. Despite the December data indicating a worsening scenario for the Bank of Canada's preferred core measures, the percentage of the consumer price basket witnessing unusually high inflation over the last three months continued to shrink. Notably, a significant portion of overall price growth stems from an escalation in mortgage interest costs, directly attributed to earlier interest rate hikes.
A softening economic backdrop characterized by slowing consumer demand, declining per-capita GDP, and an increase in unemployment provides valid reasons to anticipate a sustained downtrend in inflation readings. Q4 witnessed a contraction in total hours worked for the first time since Q2 2020, signalling downside risks to the Bank of Canada's prior forecast for a 0.8% Q4 GDP gain.
Despite these challenges, the Bank of Canada is cautious about prematurely declaring victory over inflation. Projections suggest that the first reduction in the overnight rate is anticipated around the middle of this year, with an additional rate cuts expected later in the year. This trajectory aims to lower the overnight rate to 4% - 4.25% by the end of 2024, reflecting the central bank's measured approach to navigating the complex interplay of economic factors influencing monetary policy decisions.
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