The central bank's increase earlier this month pushed up its policy rate to a multi-decade high of 5%
In its latest summary of deliberations covering its July hike, the Bank of Canada said that it will strive to not raise its policy rate more than it needs to despite sustained pressure from excess demand and elevated core inflation.
The BoC’s hike earlier this month pushed up the benchmark interest rate to a multi-decade high of 5%.
“Monetary policy needed to be more restrictive to slow growth of demand in the economy to achieve the 2% target,” the central bank said. “[Governing Council] agreed that both excess demand and underlying inflation were looking more persistent.
“They also agreed that while long-run inflation expectations still looked reasonably anchored, with inflation projected to be above target for another year, they needed to be alive to the risk that near-term inflation expectations could remain high, making it harder to restore price stability.”
The Bank added that the cost of delaying this month’s hike was much larger than the benefits of waiting for more evidence to build the case for further tightening.
“With inflation projected to be around 3% for the next year and with the upside risks to inflation expectations and household spending, Governing Council members were concerned that the progress toward price stability could stall, and inflation could even rise again if upside surprises materialize,” the BoC said.
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The July hike was also decided upon as the central bank found that the economic impacts of the previous policy rate adjustments were lagging significantly.
“Given the unusual circumstances of the pandemic and the recovery, and the accompanying large movements in inflation and expected inflation, the increases in the policy interest rate may be taking longer to work their way through the economy than historical experience would suggest,” the Bank said.
The institution decided that the latest hike is the closest move to striking a balance between the risks of under- and over-tightening.
“If policy is not restrictive enough to bring inflation to target on a reasonable timetable, there is a risk that rates will have to be increased by even more later,” the BoC said. “If policy is simply taking longer to work because the lagged effects of nominal tightening are only recently starting to have an impact on overall consumption, over-tightening risks making economic conditions more painful than necessary.”
