While acknowledging that inflation “has come down a lot since the summer of 2022,” the Bank of Canada believes it will take until 2025 to reach the target 2% inflation rate.
“We expect inflation to ease gradually and return to the 2% target in 2025. But we’re worried that higher energy prices and persistence in underlying inflation are slowing progress,” the bank said in a statement.
This remark comes after the central bank held its policy interest rate unchanged at 5%, as it continues its policy of quantitative tightening.
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This decision comes amidst a backdrop of decelerating global economic growth, with a forecasted GDP growth of 2.9% this year, further dipping to 2.3% in 2024, but recovering slightly in 2025 at 2.6%.
However, the Governing Council said it is still concerned that “progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed.”
In explaining the rate decision, the bank said that global economic growth is decelerating as expected due to the impact of higher interest rates and tighter financial conditions, which are curbing demand. However, there have been some variations in the economic landscape compared to its July forecasts. Notably, the US economy has exhibited surprising strength, while China’s slowdown has been more pronounced than initially projected.
Simultaneously, the Bank of Canada also noted the escalations in geopolitical tensions. The ongoing Russian aggression in Ukraine and the Hamas attacks in Israel have sparked conflict in Israel and Gaza.
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Despite seeing that “tighter monetary policy is reducing price pressures for many goods and services,” the bank’s outlook “for near-term inflation is higher.”
“Higher energy prices, structural pressures in our housing market and stickiness in underlying inflation are all slowing the return to target,” the bank added.
Another factor that could move the needle towards higher inflation, as Governor Tiff Macklem noted in his remarks, is government spending, adding that “It’s going to be easier to get inflation down if monetary and fiscal policy are rowing in the same direction.”
“For next year, we expect government spending to be about 2.5%… government spending will be adding to demand more than supply is growing. And in an environment where we’re trying to moderate spending and get inflation down, that’s not helpful,” Macklem said.
The bank estimates, considering all factors, that inflation will be about 3.5% through to about the middle of next year. And as excess supply in the economy increases, inflation should ease further in 2024 and reach 2% in 2025.
“We don’t want to cool the economy more than necessary. But we don’t want Canadians to have to continue to live with elevated inflation either…” the bank explained. “If inflationary pressures persist, we are prepared to raise our policy rate further to restore price stability.”
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