Bank of Canada was right to hold interest rates steady, even if that was difficult
Don Drummond is a fellow-in-residence at C.D. Howe Institute and a Stauffer-Dunning Fellow at Queen’s University. He was formerly chief economist at Toronto-Dominion Bank and an associate deputy minister at Finance Canada.
Perching on the fence is uncomfortable for many reasons. First is the long lag time between setting interest rates and seeing the result. It can take 18 months or more for changes in interest rates to affect economic activity and then inflation. The bank’s rate hikes over the past year are moving inflation in the right direction. The year-over-year rate of inflation declined in February to 5.3 percent, well off its peak of 8.1 per cent in June, 2022.
All of these indicators, however, are precisely why the Bank of Canada was right to hold its interest rate on Wednesday. The bank’s Business Outlook Survey for the first quarter of 2023 revealed expectations of slower sales growth and an easing of labour shortages and wage growth pressures, despite the unemployment rate remaining low at about 5 per cent.
The third factor is a broader perspective on credit and financial variables that suggests conditions are not that tight. The target rate has increased 425 basis points in a year – unprecedented. But other interest rates have not increased by nearly as much. Five-year to 30-year bonds yields are only around 3 per cent, in negative territory in real terms.
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