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Bank of Canada hikes rate to 5%, expects inflation to be above 2% until mid-2025

The overnight rate is at the highest level since 2001.

Governor of the Bank of Canada Tiff Macklem leaves after a press conference at the Bank of Canada in Ottawa after the release of the 2023 bank's financial system review on Thursday, May 18, 2023. THE CANADIAN PRESS/ Patrick Doyle
The Bank of Canada raised its key lending rate, as widely expected, by a quarter-point on Wednesday. THE CANADIAN PRESS/ Patrick Doyle (The Canadian Press)

The Bank of Canada hiked its benchmark interest rate by a quarter-point on Wednesday to five per cent as the central bank predicts it will take even longer for inflation to return to its two per cent target.

"CPI inflation is forecast to hover around 3 per cent for the next year before gradually declining to 2 per cent in the middle of 2025," the central bank said in a statement.

The new forecast predicts inflation will come back down to target about six months later than it anticipated earlier this year.

If we don't do enough now, we will likely have to do even more later. But if we do too much, we risk making economic conditions unnecessarily painful for everybodyTiff Macklem, Bank of Canada governor

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"We are concerned that the progress to price stability could stall and inflation could even rise again, if there are upside surprises," Governor Tiff Macklem said in a press conference.

He emphasized getting inflation back to two per cent could help shield Canadians against price shocks in the future.

"If inflation is fluctuating between one and three per cent, basically, that means one year to the next, they don't really need to worry about big changes in their cost of living. It gives them a certain level of certainty," Macklem said.

BMO Capital Markets chief economist Doug Porter says Macklem's concerns on inflation progress were "perhaps the most telling comment."

"Today's move can be characterized as a moderately hawkish hike, in that the BoC is certainly not closing the door on the possibility of further moves. … In conjunction with the surprising resiliency of the economy, the Bank is also still quite concerned about persistent underlying inflation," Porter said.

Borrowing rates highest in 22 years

Wednesday’s hike, which was widely expected, brings the overnight rate to the highest level since 2001.

“While the Bank expects consumer spending to slow in response to the cumulative increase in interest rates, recent retail trade and other data suggest more persistent excess demand in the economy. In addition, the housing market has seen some pickup,” the central bank said.

Macklem discussed the need to balance the risks of over- and under-tightening monetary policy.

"If we don't do enough now, we will likely have to do even more later. But if we do too much, we risk making economic conditions unnecessarily painful for everybody," he said.

The Bank also raised its GDP growth forecast for this year in its Monetary Policy Report.

It now sees the economy expanding 1.8 per cent in 2023, up from 1.4 per cent in its April Monetary Policy Report. It also trimmed its projection for 2024 to 1.2 per cent, from 1.3 per cent.

The central bank resumed its hiking campaign last month after pausing in March to assess how the economy has been handling higher rates.

The data showed inflation slowed to 3.4 per cent in May but remained above its target of two per cent and the jobs market in June snapped back, with employers adding three times as many jobs as economists predicted.

The last hike?

While the central bank didn’t fully close the door to additional hikes in the future, it didn’t explicitly say it was considering raising rates further either.

“The text simply said that Governing Council will continue to evaluate the need for further rate increases based on incoming data. We see this as the peak for rates in this cycle,” Royce Mendes, managing director and head of macro strategy at Desjardins, said in a note to clients.

Stephen Brown, deputy chief North America economist at Capital Economics, also thinks this hike is “likely to be the last in this cycle.”

“With the labour market loosening, core inflation declining and the survey indicators implying that inflation expectations are normalising, we expect the Bank’s next move to be a rate cut – albeit not until 2024,” Brown said.

“Despite the Bank’s hawkish bias and continued concern that 'that progress towards the 2 per cent target could stall', we expect a further slowdown in GDP growth and evidence of easing core inflation to persuade the Bank to keep policy on hold over the rest of the year.”

Meanwhile, BMO's Porter is pushing his call for rate cuts out to the second quarter of next year, a quarter later than previously thought.

Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.

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