A Decisive Stance: Bank of Canada Holds Policy Rate and Continues Quantitative Tightening Amid Global Economic Shifts

In a pivotal move, the Bank of Canada has decided to maintain its target for the overnight rate at 5%, with the Bank Rate at 5¼% and the deposit rate at 5%. This decision, announced on January 24, 2024, reflects the Bank's continued adherence to a policy of quantitative tightening amidst a global economic landscape characterized by slowing growth and gradually easing inflation.

The global economic context plays a significant role in this decision. The United States, for example, has experienced stronger-than-expected growth but is predicted to see a slowdown in 2024, marked by reduced consumer spending and business investment. The euro area is currently grappling with a mild economic contraction, while China faces challenges such as low consumer confidence and policy uncertainty. Interestingly, oil prices have dropped, sitting around $10 per barrel lower than the October Monetary Policy Report (MPR) projections. Financial conditions, which had tightened last autumn, have now somewhat relaxed.

In terms of global economic growth, the Bank of Canada forecasts a pace of 2½% in 2024 and 2¾% in 2025, following a rate of 3% in 2023. This slower growth is expected to result in a gradual reduction in inflation rates across advanced economies, with the aim of meeting central bank targets by 2025.

Focusing on Canada, the domestic economy has been relatively stagnant since mid-2023, with anticipations of remaining near zero growth through the first quarter of 2024. High prices and interest rates have led to reduced consumer spending, and there has been a contraction in business investment. The labor market is showing signs of relaxation, with job vacancies nearing pre-pandemic levels and a slowdown in job creation compared to population growth. Nevertheless, wages continue to rise at a rate of about 4% to 5%.

Looking ahead, the Bank of Canada predicts a gradual strengthening of economic growth around the middle of 2024. Factors contributing to this include an expected uptick in household spending, a boost in exports and business investment from recovering foreign demand, and substantial government spending. The Bank projects GDP growth of 0.8% in 2024 and 2.4% in 2025, aligning closely with its October forecast.

Inflation remains a significant factor in the Bank's decision-making. The Consumer Price Index (CPI) inflation ended the previous year at 3.4%, with shelter costs contributing significantly to above-target inflation. The Bank anticipates inflation to hover around 3% in the first half of the year before gradually decreasing, aiming to reach the 2% target by 2025. Despite a reduction in demand-related price pressures and normalization in corporate pricing behavior, there is yet to be a sustained decline in core measures of inflation.

The Governing Council's decision to maintain the policy rate and continue with balance sheet normalization reflects its ongoing concerns about inflation risks, particularly the persistence of underlying inflation. The Council is closely monitoring various factors, including the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behavior. The Bank of Canada's commitment to restoring price stability for Canadians remains steadfast.

For the Canadian Dollar, the impact of these decisions and forecasts is multifaceted. The maintenance of the current policy rate indicates a stable approach by the Bank of Canada in navigating economic uncertainties. This stability can bolster investor confidence in the Canadian Dollar. However, the global economic slowdown and domestic challenges, such as modest GDP growth projections and persistent inflation, might temper the optimism. The Canadian Dollar's strength will, therefore, depend on how these domestic and global economic factors play out in the coming months, particularly in relation to other major currencies and economies. As always, traders and investors in the forex market should stay attuned to these developments, as they can significantly influence currency valuations and trading strategies.

Cited from https://www.bankofcanada.ca/2024/01/fad-press-release-2024-01-24/