The Bank of Canada (BoC) on Wednesday held its key overnight rate at 5.0% as expected and said the path to avoid a recession had narrowed, while leaving the door open to more rate hikes to tame inflation that could exceed its target for another two years.
The bank increased rates 10 times between March 2022 and this July, with inflation peaking at more than 8% last year. Inflation in September dipped to 3.8% from 4.0% in August, and the central bank said it would average 3.5% through mid-2024.
Inflation is expected to return to the 2% target by the end of 2025, slightly later than July's forecast of mid-2025, "but the near-term path is higher because of energy prices and ongoing persistence in core inflation," the BoC said.
"Progress towards prices stability is slow and inflationary risks have increased," it said, reiterating language from previous policy decisions that it is still prepared to raise rates further if needed.
Inflation will decline to around 2.5% in the second half of 2024, the bank said.
"We've made a lot of progress, but we're not there yet," BoC Governor Tiff Macklem told reporters.
The BoC is "really driving home the point that they still have a tightening bias and any significant, upside surprise on growth or inflation could be met with further rate hikes and I think that's about the appropriate stance to take," said Doug Porter, chief economist at BMO Capital Markets.
On the dovish side, gross domestic product is seen rising at an annualized rate of 0.8% in both the third and fourth quarters of 2023. The BoC in July forecast third-quarter annualized growth of 1.5%.
The BoC cut its 2023 growth estimate to 1.2% from 1.8% in July and said 2024 growth would be 0.9%, down from a previously forecast 1.2%. The global economy is slowing and a recent surge in global bond yields is weighing on demand, the bank said.
"The path to a soft landing is narrow, and in this projection, that path has gotten narrower," Macklem said.
The Canadian dollar weakened to a seven-month low at 1.3795 per U.S. dollar, or 72.49 U.S. cents, down as much as 0.4% on the day.
"There is growing evidence that past interest rate increases are dampening economic activity and relieving price pressures," the BoC said in a statement. "A range of indicators suggest that supply and demand in the economy are now approaching balance."
Wages continued to grow between 4% and 5% annually and core inflation measures have shown "little downward momentum," the bank said.
"Given this sort of dovish tone around the economy, it feels like it would be difficult to see the BoC change their direction quick enough to do anything in December," said Andrew Kelvin, chief Canada strategist at TD Securities.
Among the risks cited were oil prices, which are higher than had been assumed in July, and the war in Israel and Gaza, which adds to geopolitical uncertainty, the BoC said.
The central bank is probably done raising rates and will hold them at a 22-year high of 5.0% for at least six months, according to a Reuters poll of economists published on Friday.
Money markets now price in a 14% chance of a rate hike in December.
