July 2023 BoC: Everything is Looking Persistent

The Bank of Canada did not disappoint, with another 25bp hike to 5.00% in July, lifting the overnight rate to its highest level since 2001. The Bank cited "an accumulation of evidence that excess demand and core inflation are proving more persistent" as the key rationale for its decision, alongside substantial upgrades to its projections in the July MPR. The rest of the policy statement was equally hawkish, with the Bank expressing its concern over recent strength and the risk that disinflationary pressures could stall before reaching target. The Bank also left its forward guidance unchanged to preserve the option of hiking rates again this fall.

A Brighter Outlook

The Bank's policy statement noted that the Canadian economy has been stronger than expected, and the upward revisions in the July Monetary Policy Report underscore how far things have shifted since April. The Bank now looks for real GDP to rise by 1.8% in 2023, up 0.4pp from April or 0.8pp from January (when the Bank signalled its conditional pause). The Bank is tracking 1.5% for Q2 GDP (vs 1.0% in July), and it expects some of this momentum to persist with Q3 GDP growth also projected at 1.5%. 2024 GDP forecasts saw a minor downgrade (-0.1pp to 1.2%) to offset a portion of the 2023 upgrade, but the Bank is still facing a longer timeline to bring the economy back into balance with a return to excess supply now expected in early 2024 instead of 2023H2.

The Bank also revised CPI forecasts higher over 2023 and 2024, with inflation projected to average 3.7% this year before slowing to 2.5% in 2024, which are both 0.2pp higher than April. As a result, the Bank now looks for inflation to return to target in the first half of 2025, six months later than previously expected, alongside the nine-month delay for the return to excess supply.

A Surprisingly Hawkish Tone

We anticipated the stronger MPR projections, but the tone of the policy statement was considerably more hawkish than we expected. There was very little nuance in the July communiqué, with the Bank downplaying recent progress in the labour market and business/consumer surveys for Q2. The Bank cited tight labour market conditions and noted that wage growth has been around 4-5% despite the BoC's wage-common composite falling to 2.8% in Q1, and even the permanent-workers measure from the Labour Force Survey fell below 4% in June. The Bank also noted more persistence in underlying price pressures across the BOS/CSCE, despite the continued moderation for measures of inflation expectations (which still remain above pre-COVID levels).

The hawkish tone was also reflected in the longer timeline for returning inflation to target, as the statement noted that "Governing Council remains concerned that progress towards the 2% target could stall, jeopardizing the return to price stability." The opening sentence of the final paragraph also read more hawkish as the Bank stressed the persistence of excess demand and core inflation momentum, which hints at the risk of further tightening this fall if growth and inflation do not moderate as we expect.

Bank Will Remain Data Dependent

Overall, we see this as a "hawkish hike" with the Bank signalling that it will remain data dependent into the fall given the persistence of excess demand and core inflation. We are sticking with our call for a 5.00% terminal rate, but we would also emphasize that this is predicated on the assumption of below-trend growth over the rest of 2023, along with some further moderation of inflation pressures. The July statement suggests the bar to further tightening might be lower than we anticipated, but we still want to see confirmation that the outlook has strengthened before we discuss the prospect of hiking beyond 5.00%. It's worth remembering that in uncertain economic environments, the tone of the communiqué can change sharply from meeting to meeting.