The Bank of Canada hiked its key interest rate 25 basis points on Wednesday, ending its three-month pause on increases, as the Canadian economy runs hotter than expected.
The increase brings the central bank's target for the overnight rate to 4.75 per cent, the highest level since May 2001, and restarts its tightening campaign as policymakers continues to try to tame inflation.
The central bank came off the sidelines on Wednesday after several indicators showed unexpected resilience in the Canadian economy in recent weeks.
"Overall, excess demand in the economy looks to be more persistent than anticipated," the central bank said in a statement alongside its interest rate decision.
"Based on the accumulation of evidence, Governing Council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the two per cent target."
While Wednesday's decision came as a surprise to many economists, it quickly opened the door to further hikes. Money markets now see a more than 60 per cent chance of another rate hike coming in July, according to Reuters, with further tightening in September fully priced in.
"Bet you can't just have one," TD senior economist James Orlando wrote in a note on Wednesday, adding that the central bank "is back in hiking mode."
"Economic data are pointing to more strength and the Bank has yet to see any sign from the labour market that the economy is turning," Orlando wrote.
"We expect the BoC to hike again in July, bringing the policy rate to 5 per cent."
The Bank of Canada highlighted several indicators in the statement released alongside its decision on Wednesday, including strong GDP growth and a rebound in demand for services. It also flagged a resurgence in housing market activity, and a tight labour market.
Canada’s economy grew 3.1 per cent in the first quarter of the year, stronger than what analysts and the Bank of Canada had expected, as household spending remained strong. Inflation reversed course in April, increasing 4.4 per cent, marking the first acceleration since June 2022.
The Bank of Canada had held its key interest rate steady since March, when it became the first major central bank to pause interest rate hikes, to assess the impact of its aggressive tightening cycle.
The central bank has repeatedly said that it was "prepared to raise interest rates further if needed to return inflation to its 2 per cent target." While that phrase was absent from Wednesday's statement, the central bank said it "will continue to assess the dynamics of core inflation and the outlook for CPI inflation." It still expects CPI to ease to around 3 per cent this summer, but noted that "concerns have increased that CPI inflation could get stuck materially above the 2 per cent target."
Bank of Canada 'won't be quite as patient as we expected'
CIBC economist Avery Shenfeld noted that "the Bank's actions today signalled that it won't be quite as patient as we expected in its wait to see economic slack emerge." While Shenfled expects a follow-up 25 basis point hike "as a final fine tuning," he said that September was more likely timing than July "due to the need to gather enough additional insights on the lagged impacts of all the rate hikes thus far."
Royce Mendes, Desjardins' head of macro strategy, said in a note released shortly after the Bank issued its decision that it's unlikely the central bank will "see enough progress towards restoring price stability before their next scheduled rate decision for this to be the final hike of the cycle." He wrote that Desjardins' is leaning towards another 25 basis point hike in July.
CIBC economist Katherine Judge said in a note that an additional hike in July is still on the table as the bank deals with sticky inflation and persistent excess demand.
"It's therefore possible that we could see a follow up hike if signs of economic slack opening up aren't clear in the forthcoming data," Judge wrote.
Note: A previous version of this story stated that the policy rate was last at 4.75% in 2007. The last time the Bank of Canada's policy rate was 4.75% was in fact May 2001.
Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.