Bank Of Canada Holds Key Interest Rate At 0.25% Despite Rising Inflation

The Bank of Canada surprised markets by deciding to hold interest rates at their current levels despite inflation rising at its fastest pace in 30 years.

The central bank signaled that it will undertake a series of interest rate hikes this year starting in March as it dropped its forward guidance that it would keep its key policy rate at its rock-bottom level of 0.25%, which is where it has been since March 2020 during the first wave of the pandemic.

A majority of economists polled by the Reuters News Agency had expected the Bank of Canada to lift its benchmark interest rate by 0.25 basis points yesterday (January 26). The next opportunity for the central bank to move on interest rates is in March.

The Bank of Canada said indicators now suggest the economy is running at capacity, including a labour market that is back at pre-pandemic levels, with growth over the last few months stronger than senior decision-makers had anticipated.

The economic rebound is why the central bank will no longer promise to keep its key policy rate at what it calls the effective lower bound, as governor Tiff Macklem said rates need to rise to cool inflation back down to the central bank's 2% target.

He pointed to the rapid spread of the Omicron variant as an economic “wild card” to explain why the bank held off on raising rates now.

The central bank's next scheduled rate call is in five weeks, setting up March as a month of monetary tightening on both sides of the border after the U.S. Federal Reserve also said yesterday that rate hikes will soon be needed.

In an updated economic outlook, the Bank of Canada said that consumers would continue to feel the impact of faster price growth, particularly at the grocery store, with headline inflation likely to creep above 5% during the first quarter before easing by the end of the year.

Inflation for 2022 is forecasted to clock in at 4.2%, up from 3.4% in the bank's previous forecast issued in October, and faster than what the consumer price index registered for all of 2021.

The Bank of Canada estimated that the economy grew by 4.6% in 2021, down half a percentage point from its previous forecast in October, and now projects growth in real gross domestic product in 2022 of 4%, down from 4.3% previously.

Part of the downgrade is due to governments cutting spending earlier than expected, and supply-chain issues that will have broader implications for economic activity and prices, said the Bank of Canada in a news release.