Bank of Canada Hikes by 25 bp, Warns Inflation Downward Momentum Will Slow

BANK OF CANADA DECISION KEY POINTS:

• Bank of Canada raises its overnight rate by 25 basis points to 5.00%, in line with expectations
• The monetary authority warns that progress on the inflation front will be slower going forward, implicitly leaving the door open to further tightening
• USD/CAD sinks following the central bank’s decision and guidance

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The Bank of Canada today concluded its July monetary policy meeting, voting to raise its benchmark interest rate by 25 basis points to 5.0%, the highest level in 22 years, as part of the ongoing fight against persistently high inflation.

Wednesday’s move marks the second consecutive and back-to-back quarter-point hike by the institution, following last month’s decision to resume the tightening campaign and abandon the conditional pause announced in January.

In its statement, the BoC said the economy has been stronger than expected, adding that consumption has been surprisingly solid and that labor markets remain tight. In addition, the institution led by Tiff Mcklen indicated that recent data continues to point to excess demand, an economic condition that tends to be inflationary by definition.

On the inflation outlook, the BoC acknowledged that price growth has softened, but also that the directional improvement in the overall trend has largely stemmed from lower energy prices rather than from underlying pressures. In this context, the bank warned that progress on the CPI front will be slower, a sign that policy will have to stay restrictive for longer.

In terms of the hiking cycle, guidance was somewhat hawkish. While policymakers did not explicitly say that more tightening is on the horizon, language indicating that “excess demand and core inflation” are proving to be more persistent than anticipated clearly leaves the threat of more hikes on the table.

Immediately after the Bank of Canada’s announcement crossed the wires, USD/CAD extended its daily decline, falling to its lowest level since June 27. The possibility that the Bank of Canada will raise borrowing costs again later this year should be somewhat supportive of the Canadian dollar in the near term, although much will also depend on the Federal Reserve’s stance.

USD/CAD 5-MINUTE CHART