OTTAWA (Reuters) -The Bank of Canada signaled on Wednesday it could hike interest rates three months sooner than previously forecast and warned that inflation would stay above target for much of 2022, due to higher energy prices and supply bottlenecks.
The central bank held its key overnight interest rate at 0.25%, as expected, and said it was ending its bond-buying program, citing Canada’s robust economic growth, high COVID-19 vaccination rates, and strong employment gains.
“The Canadian economy is once again growing robustly,” it said in its quarterly monetary policy report. “The Bank now expects economic slack will be absorbed sometime in the middle quarters of 2022.”
It added that this timing was “more uncertain than usual”, due to the challenges of reopening an economy still affected by COVID-19.
“There’s really no need for an ultra-stimulative monetary policy at this point,” said Doug Porter, chief economist for BMO Capital Markets. “We now expect them to start raising rates in July of next year, and we would look for hikes of a quarter point per calendar quarter.”
Money markets now see the first rate hike coming in March, compared with April before the announcement.
The Canadian dollar was trading 0.5% higher at 1.2327 to the greenback, or 81.12 U.S. cents, while the 2-year yield touched its highest since March 2020 at 1.147%, before dipping to 1.073%, up 20.6 basis points on the day.
The Bank had previously forecast a full recovery would happen sometime in the second half of 2022 and that it would keep rates at current levels until that happened.
But slower growth coupled with supply-chain disruptions suggest the output gap is narrower than previously thought, the bank said. On Wednesday, the central bank cut Canada’s economic growth outlook this year to 5.1% from 6.0% in its July forecast.
Headline inflation is expected to remain above its 1% to 3% control range for longer than previously thought, the bank said, easing back closer to target in late 2022. It forecast inflation at 4.8% in the fourth quarter of this year, easing to 2.1% in the fourth quarter of 2022.
“These upward revisions reflect the larger and more lasting impacts from supply constraints as well as higher energy prices,” it said.
Those supply-chain bottlenecks should be largely resolved by the end of next year, it said. Strong foreign demand is set to drive a solid export recovery, while business investment outside of the oil and gas sector should rise as supply constraints ease.
The Bank said the bond-buying program that was used to stem the economic fallout of the coronavirus pandemic will now move into the reinvestment phase, where it will purchase only enough Canadian government bonds to replace those that are maturing.
Bond-buying will end Nov. 1 and the target range for total purchases will initially be between C$4 billion and C$5 billion per month.
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