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Bank of Canada holds key rate at 5%, signals it's done with hikes

In a move widely anticipated by both markets and economists, the Bank of Canada has decided to keep its policy rate unchanged at five percent for the fourth consecutive meeting. Governor Tiff Macklem, leading the policymakers, explicitly stated that there would be no need for further increases if the economy unfolds as per their expectations.

The decision reflects the bank's acknowledgment of a stalled economic growth trajectory, expected to persist in the near term. The slowdown is viewed as instrumental in bringing inflation back to the bank's target of two percent by the following year.

During his prepared remarks, Governor Macklem highlighted a consensus among policymakers to maintain the policy rate at the current five percent. What emerged from the discussions was a shift in the focus from debating the restrictiveness of monetary policy to deliberating the duration of maintaining the existing restrictive stance.

The bank's communications conveyed a dovish tone, suggesting a perception of a rapidly slowing economy. The belief is that the past rate hikes, totaling 475 basis points in less than two years, should be adequate to curb inflation. This shift potentially leaves the door open for rate cuts in the coming months.

Governor Macklem emphasized that future discussions would likely revolve around how long the bank should keep the policy rate at five percent, given the anticipated economic scenario.

Following the announcement, the Canadian dollar experienced a decline, erasing earlier gains and trading at US$1.3468 at 9:54 a.m. New York time. The yield on the benchmark two-year note also saw a decrease of about four basis points to 4.006 percent on the day.

While Governor Macklem reiterated the need to balance the risks of both over- and under-tightening, he also expressed concerns about the persistence of underlying price pressures. Policymakers, however, removed the language from previous statements indicating a preparedness for further rate hikes.

The bank's focus remains on achieving "further and sustained easing" in core inflation. Key factors include the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing activity, as outlined in the bank's statement.

Forecasts suggest that the economy is currently in a state of "modest excess supply." The bank revised its economic growth projection to 0.8 percent for the current year, down from 0.9 percent. Despite the adjustment, the Bank of Canada maintains its base case of a soft landing, anticipating growth to pick up around the middle of the year.

Inflation is expected to hover close to three percent in the first half of 2024, before gradually declining to around 2.5 percent by the end of the year. The bank anticipates a return to its two percent target in the following year.

Notably, the consumer price index accelerated to a 3.4 percent yearly pace in December, exceeding the 3 percent cap of the central bank's target operating band for 32 of the past 33 months.

The bank also identified housing-related factors as potential risks to inflation. A stronger-than-expected rise in house prices could drive inflation higher than anticipated.

In a unique position compared to its peers, Canada's economy is considered more rate-sensitive due to higher debt loads and shorter-duration mortgages. The prevailing sentiment among economists is that the Bank of Canada might cut the policy rate by June, a sentiment shared by traders in overnight swaps.