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Bank of Canada raises key interest rate as it tries to get ahead of hot economy

The central bank's key interest rate now sits at 4.75%, the highest it's been since 2001
bank of canada

As the economy continues to outperform expectations, the Bank of Canada has chosen to act sooner rather than later to clamp down on inflation, raising its interest rate by a quarter of a percentage point on Wednesday (June 7).

Its key interest rate now sits at 4.75%, the highest it's been since 2001.

"Based on the accumulation of evidence, governing council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand into balance and return inflation sustainably to the two per cent target,'' the Bank of Canada said in a news release.

READ: Canadian consumers pull back on spending amid high prices, interest rates

It says excess demand in the economy appears to be more persistent than it had anticipated, citing a tight labour market, better-than-expected economic growth in the first quarter as well as "surprisingly strong'' consumption growth.

Inflation also came in hotter than expected in April, the central bank said, noting prices for a "broad range'' of good and services rose might than anticipated.

The decision to raise interest rates comes after speculation among economists and forecasters that ongoing strength in the Canadian economy would push the central bank to hike rates again, though many expected the central bank would wait until the summer before pulling the trigger.

Royce Mendes, managing director and head of macro strategy at Desjardins, said the rate hike isn't too surprising given economic indicators released since the last rate decision suggest the economy is still overheated.

READ: Bank of Canada holds key interest rate at 4.5%, bumps up growth forecast for 2023

"It makes complete sense that if the bank thought it needed to raise rates, it should do so earlier, rather than later,'' Mendes said.

However, the economist criticized the central bank for not communicating its intentions clearly ahead of time. Notably, governor Tiff Macklem didn't seem overly concerned about the rise in inflation in April during a news conference last month, he said.

"The Bank of Canada should be doing a better job of communicating their intentions to the (financial) market,'' Mendes said.

Looking ahead, the central bank says it will continue to monitor the economy and evolution of inflation, dropping any language it was pausing rate hikes, which has appeared in the text of rate announcements since January.

READ: With lower commodity prices, why aren’t food prices dropping?

Mendes said although the Bank of Canada's news release says very little about where it plans to take interest rates, he's expecting another rate hike in July.

"We continue to lean towards another 25 basis point rate hike at the next rate decision, only because I don't think the bank will have seen enough progress towards restoring price stability before that date,'' he said.

In January, the Bank of Canada announced it would pause its aggressive rate-hiking cycle that began in March 2022. The central bank appeared cautiously optimistic that interest rates might be high enough to quash inflation, although it stressed that the pause was conditional on inflation falling and the economy softening.

Since then, incoming economic data has continued to surprise forecasters who had anticipated the economy to stall by now. Despite elevated interest rates making borrowing more expensive for consumers and businesses, businesses are still hiring, and consumers continue to spend.

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And even as the population grows rapidly, new workers have been absorbed quickly into the labour market, keeping the unemployment rate at five per cent for five consecutive months. That's just above the all-time low of 4.9% reached last summer.

On the inflation front, price growth has slowed significantly since peaking at 8.1% last year. However, the annual rate ticked up slightly in April to 4.4%, marking the first rise in inflation since the summer.

The central bank says it still expects inflation to fall to about 3% in the summer, but with core inflation still elevated its concerns about inflation getting stuck above two per cent have increased.

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