The Bank of Canada (BoC) raised interest rates by 25 basis points on Wednesday for the second straight meeting. This brought the cost of borrowing to 5.0%, the highest level since 2002.
The BoC’s statement following the meeting at which a 0.25% rate hike was announced noted that Bank officials were concerned that a return to the 2% inflation target “could stall, jeopardizing the return to price stability.” The statement noted that core inflation, which excludes food and energy, has proven more persistent than the BoC had expected.
Inflation remains the public enemy number one for the BoC, and the rate increase demonstrates that although inflation has been brought under control and is falling, getting to the 2% target will be a challenge.
Ahead of the rate announcement, the money markets had priced a hike at 75%, and all six major Canadian banks had projected a rate increase. This indicates that the rate increase was not a surprise, but the Canadian dollar still made some gains on the back of the rate increase.
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The BoC released a monetary policy report at the rate meeting, which indicated that inflation is expected to hover around 3% in 2024 and decline to 2% in mid-2025. Earlier projections had forecast that inflation would fall to 2% by late 2024.
The BoC’s decision to raise rates and the rate statement and policy report indicates deep concern that inflation has been stickier than anticipated and has left open the door for additional hikes, which will depend on the data, especially employment and inflation releases.
The Canadian benchmark stock market index, the S&P/TSX, rose sharply, and the Canadian dollar gained ground following the BoC rate hike.
The S&P/TSX rose 192.21 points on Wednesday and closed at 20,070.77, for a gain of 0.97%.
The US Dollar against the Canadian Dollar opened on Wednesday at 1.3230 and climbed as much as 90 pips but pared these losses and closed the day up 45 pips at 1.3185.
On Thursday, the Canadian Dollar extended its gains and is trading at $1.3156.
US CPI (inflation) fell in June for a twelfth consecutive month and dropped to 3.0%, its lowest level since March 2021.
On a monthly basis, CPI rose 0.2% in June, as did Core CPI, which excludes food and energy. This was better than the 0.3% consensus estimate and lower than the May numbers. On an annualized basis, CPI fell from 4.0% to 3.0%, and the core rate dropped to 4.8%, down from 5.3%.
The inflation report was clearly good news for the Federal Reserve, which has been aggressively raising rates in order to curb inflation. Still, inflation remains well above the 2% target, and the Fed is widely expected to raise rates by 0.25% at the July 26th meeting.
The drop in inflation and the decline in nonfarm payrolls last week showed that the US economy is cooling, but we could still see additional rate hikes after the July meeting. The labor market is still tight, and wage growth remains stubbornly high. The battle with inflation is clearly moving in the right direction, but getting inflation down to the 2% target may prove to be more difficult than curbing inflation when it was closer to 10%.
The positive inflation report has raised market expectations of a pause in September, but there is plenty of economic data before then, and inflation and employment numbers will play a key role in rate decisions in the coming months.
The S&P 500 rose 32.90 points (0.74%) on Wednesday, closing at 4,472.16.
The Nasdaq 100 rose 188.16 points (1.24%) on Wednesday, closing at 15,307.23.
The US dollar beat a retreat against all the major currencies on Wednesday and slid over 1% against the Euro, the Japanese Yen and the Australian Dollar. On Thursday, the US dollar was calm, but the Aussie continued to rally.