Bank of Canada hikes most since 1998
Alongside a surprising 100 basis point increase to its key policy rate, the Bank of Canada also adjusted its forecast for Canadian inflation and economic growth on Wednesday amid an ongoing surge in commodity prices and rising domestic housing costs.
The Bank of Canada now expects Canada's gross domestic product for 2022 to come in at 3.5 per cent, down from a previous forecast of 4.25 per cent, and 1.75 per cent in 2023, down from 3.25 per cent.
As for inflation, the Canadian central bank said the Canadian consumer price index is poised to be "substantially higher than projected in April", with the end-of-year outlook revised higher by nearly two percentage points to 7.2 per cent.
Inflation is expected to remain persistently higher in 2023 at 4.6 per cent, an increase of 1.8 percentage points. Inflation is expected to fall closer to the bank's target of two per cent in 2024 at 2.3 per cent, according to the Bank of Canada.
The Canadian central bank updated its economic forecasts while raising interest rates by a full percentage point on Wednesday. It attributed its changes to its economic projections due to higher commodity prices and lower global demand, which may lead to lower exports and business investment.
In its quarterly Monetary Policy Report, the Bank of Canada conceded in an appendix that it has underpredicted how inflation has soared in Canada since spring 2021. It attributed two-thirds of missed inflation projections to global factors, including higher commodity prices, increased supply shortages and rising shipping costs, although one-quarter was attributed to Canada's housing market.
Commodity prices, specifically oil, accounted for about 45 per cent of the Bank of Canada's total underprediction of inflation as refinery margins have deviated from historic levels, causing a sudden increase in gas prices. In the past, the Canadian dollar has typically moved in lockstep with rising oil prices, which helped to offset inflationary pressures and made imports cheaper, but that relationship has recently decoupled, leading to an even greater effect on inflation, the Bank of Canada said.
Canada's faster-than-expected economic recovery from the COVID-19 pandemic - and the subsequent surge in consumer demand - was also noted by the central bank as having a stronger impact on inflation than first anticipated.
"In 2022, with the lifting of most public health restrictions, consumer cautiousness faded more quickly than in past downturns, and pent-up demand led to robust consumption growth," the Bank of Canada said in the report.
"With the economy already in excess demand, the effects of domestic demand on inflation became more important. These effects are contributing to a broadening of high inflation into non-shelter services such as traveller accommodation and transportation."