Bank of Canada Poised to Raise Interest Rates Amidst Economic Resilience

Speculations are rife that the Bank of Canada will once again increase interest rates this week, as experts assert that the economy has not displayed enough signs of weakening to warrant a retreat by the central bank.

Scheduled for Wednesday, the interest rate announcement comes just over a month after the Bank of Canada raised its key rate by a quarter of a percentage point, resulting in a new rate of 4.75 percent.

The decision in June marked the end of the Bank of Canada's pause on rate hikes, which was prompted by concerns that inflation would not return to its two percent target due to robust economic data. Dawn Desjardins, Chief Economist at Deloitte, acknowledged recent indications of a shifting economy, citing the latest job report for June that highlighted a rise in the unemployment rate and a deceleration in wage growth.

Nevertheless, Desjardins asserted that the overall outlook still suggests persistent inflation, strong wage growth, and a dynamic economy.

Desjardins stated, "We are observing some changes, but they may not be occurring rapidly enough to satisfy the Bank of Canada."

The Bank of Canada has chosen not to provide explicit forward guidance to financial markets regarding its plans for July. Instead, it intends to base its decision on incoming economic data as evaluated by the governing council.

One of the crucial factors closely monitored by the central bank is the labor market. The bank has cautioned that the annual wage growth rate, which has ranged between four and five percent, is insufficient to meet the two percent inflation target without accompanying productivity gains.

Economists analyzing the latest job report for June presented a nuanced analysis. The economy added 60,000 jobs, indicating sustained hiring by employers. Conversely, the unemployment rate climbed to 5.4 percent as more individuals entered the job market, while the country's population continued to grow.

Wage growth also experienced a significant slowdown, dropping to 4.2 percent last month compared to a year-on-year increase of 5.1 percent in May.

The Bank of Canada's recent business outlook survey revealed that businesses, for the first time since the onset of the pandemic, anticipate slower wage growth in the coming year.

Despite the unemployment rate remaining below pre-pandemic levels, Randall Bartlett, Senior Director of Canadian Economics at Desjardins, believes that the labor market remains tight.

Bartlett commented, "We are still observing significant underlying strength in the Canadian labor market, more so than one would expect with the overnight rate nearing five percent."

In terms of inflation, price growth has significantly decelerated since last year. In May, inflation dropped to 3.4 percent from its peak of 8.1 percent in the previous summer. However, this deceleration can primarily be attributed to lower energy prices, while other prices continue to rise. Core inflation, which excludes volatile elements, actually accelerated in May.

Both the Bank of Canada and private-sector economists acknowledge the challenge of returning inflation to the desired two percent target.

Despite widespread expectations of a recession as early as late 2022, the economy has continued to expand, even with interest rates at their highest levels in decades.

Bartlett argues that the Bank of Canada's decision to maintain a hawkish stance is warranted, stating, "I believe the bank is establishing the foundation to sustainably guide inflation back towards two percent."

Preliminary estimates from Statistics Canada suggest that the economy continued to grow in May following a stagnant April.

Bartlett's firm projects second-quarter growth at double the rate forecasted by the Bank of Canada in April. Consequently, the economist anticipates that the central bank will not only raise rates but also indicate the potential for further hikes if the economy does not sufficiently slow down.

"We believe the economy has enough strength for the bank to adopt a very hawkish tone in its statement, signaling that the possibility of additional rate hikes remains open, potentially in September."