As we are all now aware, on June 7th, 2023, the Bank of Canada made the decision to increase its interest rate. The move by the central bank has significant implications, particularly in the real estate and mortgage sectors. Recently the Bank released a summary of the deliberations of the Governing Council prior to the announcement which sheds some light on the reasons behind this increase.

Global Economic Developments

The Bank of Canada’s Governing Council began its decision-making process by reviewing recent global economic developments. It noted that global growth had largely aligned with the projections outlined in the April Monetary Policy Report. However, rising interest rates were putting pressure on growth in most regions, including the United States and the euro area. Despite monetary policy tightening by central banks, core inflation remained stubbornly high in these regions.

Furthermore, the Council discussed the banking sector stress in the United States and Europe, acknowledging that while the risk of acute stresses had decreased, it remained a factor to consider. With the resolution of the debt ceiling issue and receding banking stress, market attention shifted back to macroeconomic developments, inflation, and monetary policy. Additionally, the Chinese economy rebounded, primarily driven by services consumption and public investment, which could limit the growth in global commodity demand.

Canadian Economy and Inflation Outlook

The Governing Council reviewed the Canadian economy and its inflation outlook, considering data that had emerged since the previous decision in April. The first-quarter gross domestic product (GDP) growth surpassed expectations, driven by strong consumption growth, solid business investment, and exports. However, residential and inventory investment continued to weigh on overall growth. The Council recognized that the economy remained in excess demand, and the rebalancing of supply and demand was expected to take longer than anticipated.

The labor market conditions were characterized as tight, but some signs of easing were observed, with employment growth and job vacancies moderating. The unemployment rate remained near record lows, but wage growth had shown signs of easing. While measures of core inflation continued to decline on a year-over-year basis, 3-month measures of core inflation picked up slightly in April. Notably, housing resale prices had increased for three consecutive months, contributing to inflationary pressures.

Considerations for Monetary Policy

The Governing Council assessed whether the current monetary policy was sufficiently restrictive to bring supply and demand back into balance and sustainably return inflation to the 2% target. Despite the previous interest rate hikes, consumer demand had proven to be more robust than expected. Possible explanations for this included the delayed effects of past monetary policy tightening, longer transmission lags, excess savings, tight labor markets, strong population growth, and seasonal adjustment factors.

While the Council acknowledged that new information on inflation expectations or corporate pricing behavior was limited, they expressed concerns that the disinflationary momentum needed to reach the 2% target might be waning. This concern, coupled with increasing evidence of stronger household spending growth, led the Governing Council to conclude that a further increase in the policy rate was necessary.

The Policy Decision

Having debated the merits of raising the policy rate at the June decision or waiting until July, the Governing Council determined that enough data had accumulated to support a rate increase immediately. Thus, the Bank of Canada raised the target for the overnight rate to 4¾%. The Council also reviewed the Bank’s quantitative tightening program and agreed to continue normalizing the balance sheet by allowing maturing bonds to roll off.

The Bank of Canada’s decision to increase its interest rate on June 7th, 2023, reflects the Council’s assessment of global economic developments, the Canadian economy, and the inflation outlook. The decision was driven by concerns that the current monetary policy was not sufficiently restrictive to bring supply and demand into balance and sustainably achieve the 2% inflation target. This rate hike has implications for various sectors, including real estate and mortgages, as it may impact borrowing costs and affordability in the housing market. Market participants and stakeholders will closely monitor incoming data to assess the potential implications for economic growth and inflation in the future.