Bank of Canada signals rates could rise even in a slowdown

The Bank of Canada opened the door to future rate hikes even in a soft economy, a message that underscores just how uncertain the path ahead remains for mortgage borrowers.

In a speech in Oslo on Monday, deputy governor Sharon Kozicki said supply shocks such as United States tariffs, artificial intelligence and population aging pushed Canada into a new era where weak growth no longer guaranteed low interest rates.

The remarks came as the Bank’s policy rate sat at 2.25%, with Governing Council stressing it needs to maintain optionality on its next move after January’s hold.

“Many people may find it surprising or counterintuitive that, at times, monetary policy needs to be tightened when the economy is weak. Yet that is exactly the difficult trade-off we sometimes face,” Kozicki said.

“Generally, when a supply shock is expected to have large or persistent impacts on inflation, some degree of policy restraint will be needed to bring inflation back to target,” she said.

Kozicki pointed to rising geopolitical tensions, extreme weather and an aging workforce as factors that make supply-driven inflation pressures more common.

“Supply-side developments can lead to trade-offs for monetary policy. And sometimes, these developments can result in a combination of a weak economy and high inflation,” she said. Canada’s headline inflation rate edged down to 2.3% in January.

She emphasized that central banks could not always cut rates to cushion growth.

“When a supply shock has small or short-lived effects on inflation, central banks tend to look through the impacts as they set monetary policy. When the economy is weak, they may be able to wait for inflation to return to target on its own,” she said.

“But a look-through strategy has limits. Central banks generally should respond when the impacts of a shock on inflation are larger and more persistent.”

Kozicki added that officials would be more inclined to tighten when shocks raise costs sharply without significantly denting output, and more inclined to ease when inflation effects are muted but activity is hit hard.

Monetary policy, she said, remains a “blunt tool” that could not target specific sectors such as food, energy or rent.

“If policy doesn’t respond when there is a meaningful risk of expectations becoming unanchored from the inflation target, an even greater response will be needed later. And this could lead to an even weaker economy,” she said.

Source CMP
By Liezel Once