Bank of Canada Raises Interest Rates to Control Economy: What You Need to Know

• damiadeniyi
• July 12, 2023
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In a significant move on July 12, the Bank of Canada has decided to increase its target for the overnight interest rate to 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. This decision, aimed at managing the country’s economy, will have implications for individuals and businesses across Canada.

Here’s a breakdown of what you need to know:

Global Inflation and Economic Growth:
Global inflation is easing, primarily due to lower energy prices and a decline in goods price inflation. However, robust demand and tight labor markets are causing persistent inflationary pressures in services. Economic growth has been stronger than expected, particularly in the United States, where consumer and business spending has remained surprisingly resilient. China’s economic growth is softening, with slowing exports and ongoing weaknesses in its property sector. Growth in the euro area has effectively stalled, with the service sector continuing to grow while manufacturing contracts. Global financial conditions have tightened, with bond yields rising in North America and Europe as major central banks signal potential interest rate increases to combat inflation.

Canadian Economy:
Canada’s economy has been stronger than expected, with more momentum in demand. Consumption growth has been surprisingly strong, with a growth rate of 5.8% in the first quarter. The Bank expects consumer spending to slow down in response to the cumulative increase in interest rates, but recent retail trade data suggests persistent excess demand in the economy. The housing market has seen some pickup, with new construction and real estate listings lagging behind demand, putting upward pressure on prices. The labor market shows signs of more worker availability, but conditions remain tight, and wage growth has been around 4-5%. Strong population growth from immigration is contributing to both increased demand and supply in the economy, easing worker shortages, boosting consumer spending, and driving demand for housing.

Inflation:
Inflation in Canada eased to 3.4% in May, a significant drop from its peak of 8.1% last summer. The Bank expects inflation to gradually decline but notes that underlying price pressures appear to be more persistent than anticipated. Business surveys show that companies are still increasing prices more frequently than usual. The Bank’s projection suggests that CPI inflation will hover around 3% for the next year before gradually declining to 2% by mid-2025.

Monetary Policy and Interest Rate Increase:
Considering the evidence of persistent excess demand and elevated core inflation, the Bank has decided to increase the policy interest rate to 5%. The Bank will continue to assess core inflation dynamics, inflation expectations, wage growth, and corporate pricing behavior to ensure alignment with the 2% inflation target. In addition to the restrictive monetary policy, quantitative tightening is also being used to normalize the Bank’s balance sheet. The Bank is still dedicated to bringing back price stability for Canadians and preserving the economy’s long-term health.

Consequences for People and Businesses:
Borrowing money will cost more as a result of the higher interest rate, which will impact both individuals and businesses. People might think about cutting back on their expenditures, and firms might scale back on their ambitions for expansion. In the second half of this year and the first part of next year, the Bank predicts that economic growth will decelerate to an average pace of about 1%. The rate of inflation is being closely watched, and steps are being taken to prevent excessive price increases.