This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on January 25, 2023.

This summary reflects discussions and deliberations by members of Governing Council in stage three of the Bank’s monetary policy decision-making process. This stage takes place after members have received all staff briefings and recommendations.

Governing Council’s policy decision-making meetings began on Wednesday, January 18. The Governor presided over these meetings. Members in attendance were Governor Tiff Macklem, Senior Deputy Governor Carolyn Rogers, Deputy Governor Paul Beaudry, Deputy Governor Toni Gravelle and Deputy Governor Sharon Kozicki.

The international economy

Governing Council began discussions by reviewing recent international developments. Notable developments included:

• the substantial declines in global energy prices
• continued easing of global supply chain bottlenecks
• the abrupt lifting of COVID-19 restrictions in China

Overall, global economic activity, especially in the United States, the euro area and China, was somewhat above the Bank’s expectations in the October Monetary Policy Report (MPR). Council members continued to expect a significant slowing in global growth in 2023 as pent-up demand fades and the effects of higher interest rates restrain activity.

Inflation, while still high and broad-based, had receded from its peak in many countries, and Council members discussed at some length how market narratives about the global economy and inflation were shifting.

Council assessed the revised US outlook. They noted that US consumers had been resilient, but growth is expected to be roughly flat in 2023. The labour market remained tight. Inflation was coming down, largely due to lower energy prices, and signs of broader moderation in inflation were becoming evident. The impending debt ceiling negotiations could be protracted and pose risks of financial volatility if an agreement were elusive.

Council members continued to see the euro area moving into a mild recession, despite surprising resilience to date. Risks related to the Russian war in Ukraine continued to create uncertainty, and higher interest rates were weighing on growth.

Council spent considerable time discussing the situation in China. The rapid shift in the Chinese approach to COVID-19 was seen as a new source of uncertainty. Most notably, the outlook for oil prices was subject to an upside risk because of China’s reopening. If Chinese demand were to rebound by more than anticipated, oil prices could rise substantially, putting renewed upside pressure on Canadian and global inflation.

Council members reviewed financial conditions, noting that despite continued policy tightening by central banks, conditions had eased somewhat since October. This was considered to reflect a decline in risk premiums across asset classes because headline inflation had edged down from its peak and the perceived risk of a deep recession had decreased. The Can$/US$ exchange rate had been fairly stable at around 74 cents.

Canadian economic developments and the outlook for inflation

Governing Council reviewed recent domestic data alongside survey inputs, staff analysis and projections. Canada’s gross domestic product (GDP) grew by 2.9% in the third quarter, stronger than the Bank had expected. Members noted that strength from commodity exports offset softer household spending, with outright declines in both consumption and housing activity. Still, data to date suggested that GDP growth in the fourth quarter was also likely to come in somewhat higher than the Bank had previously projected. So, while the economy was certainly slowing, there was more excess demand than expected.

The labour market continued to show tightness. The December Labour Force Survey (LFS) reported surprisingly strong job gains. The past few months of LFS data, as well as a broader range of indicators, made it clear that the tightness in the labour market persisted. Governing Council viewed this as a symptom of an economy still in excess demand. Overall, Council concluded that wage momentum was plateauing in the range of 4% to 5%. Persistent wage growth in this range was not viewed as consistent with achieving the 2% inflation target unless productivity increases to well above its historical trend.

Consumer price index (CPI) inflation was 6.3% in December, down from the peak of 8.1% in the summer. Members agreed that momentum in inflation is turning a corner, with three-month annualized rates of inflation below the year-over-year rates for both total CPI inflation and, to a lesser extent, core measures of inflation.

Members acknowledged that much of the recent decline in headline inflation was due to lower gasoline prices, but they also viewed the decline in durable goods inflation as evidence that the effects of higher interest rates were spreading through the economy and slowing demand. Members also agreed that services inflation was likely to be persistent and acknowledged that food and shelter inflation remained particularly high.

Governing Council then turned to the revised outlook for inflation. CPI inflation was projected to decline to 3% in the middle of 2023, lower than projected in the October MPR. The decline largely reflected the fall in energy prices, weaker goods price inflation coming from slower demand, and supply chain improvements. Council was also comfortable with the forecast that inflation would decline further in 2024, reaching the 2% target. They recognized that this would require services inflation to come down and that inflation expectations and growth in labour costs would need to moderate. Risks around this outlook were viewed as roughly balanced, but the upside risks continued to be of greater concern because inflation remained too high.

Considerations for monetary policy

All Governing Council members acknowledged they were approaching this decision with a similar view: that the Bank’s monetary policy to date had been forceful and that the full impact would be felt in quarters to come. The sectors of the economy most sensitive to interest rates had clearly responded to tighter monetary policy, and evidence was starting to appear that other parts of the economy were beginning to respond.

Members viewed these as signs of progress toward restoring price stability and noted them in combination with some other key developments:

• Inflation in both Canada and globally was declining due to sizable decreases in energy prices and should decline further if energy prices stayed near current levels.
• Global supply chain disruptions were resolving.
• Markets were increasingly perceiving that much worse outcomes—even higher inflation or severe economic contractions—were less likely.

With these developments as a backdrop, Council members explored several assumptions in the Bank’s projection.

Members debated several reasons why consumption could be slower than projected. For one, many households with five-year terms on their mortgages would be renewing over the coming year or so. In many cases, they would be facing significantly higher monthly mortgage payments, and this could reduce other spending by more than expected. Higher interest rates would also encourage more savings. And members noted that consumer confidence measures had weakened, indicating households may put off major purchases.

At the same time, members also acknowledged that in Canada and in other countries, employment was strong and households had built up extra savings during the pandemic. These factors support consumption.

With respect to the housing market, there was concern that the effects of tighter monetary policy could be larger than expected. This could arise if the decline in house prices were to accelerate. At the same time, Governing Council recognized that continued strong immigration and household formation would provide underlying support for the housing market. Expectations of future monetary policy easing could also spur buyers to re-enter the market.

Members noted there could be a downside risk to the Bank’s projection for business investment: due to the activity-sensitive nature of business investment, lower levels of economic activity could curtail investment plans. Conversely, with labour in short supply, businesses could seek to invest further to expand capacity.

On labour market tightness, Council debated the extent to which it would ease as effects of reopening fade, the economy slows down, and immigration adds to the labour supply over time. There is a case for labour market tightness to persist: rebalancing the labour market may take longer than usual given firms are still facing labour shortages and given the aging workforce is reducing the growth of labour supply.

Members also discussed the risk of services inflation remaining sticky if labour costs stayed high and demand strong.

Finally, while several factors were combining to bring overall inflation down, Council discussed the risk of it becoming stuck materially above the 2% target. Persistence in supply chain challenges, services price inflation, wage growth and inflation expectations could all keep inflation above the target. A rebound in oil prices could also push inflation back up again.

The policy decision

While Governing Council was acutely aware of ongoing uncertainty, they concluded that data since the October MPR had largely reinforced their confidence that inflation would come down through 2023.

Members framed the decision along two dimensions:

• whether to leave the policy rate where it was or to increase it by 25 basis points
• whether to maintain similar forward-looking language as in the previous policy statement or to adjust it to signal a pause

The case for leaving the policy rate at 4.25% was that developments with respect to both the economy and inflation were beginning to move in the right direction and that policy had been forceful and just needed more time to do its work.

The case for raising the rate by an additional 25 basis points was twofold. First, doing so reflected the fact that developments in the real economy since the December decision had been quite strong:

• Labour market data continued to indicate tightness.
• Third quarter GDP growth was stronger than expected, and fourth quarter economic activity was also likely to be stronger than previously projected.

In other words, data on both the labour market and economic activity suggested that there was more excess demand in the economy in the fourth quarter of 2022 than previously forecast.

A second rationale for raising the rate by an additional 25 basis points related to the risk of inflation getting stuck somewhere above 2% later in the projection. Putting in place some additional tightening now could help insure against that outcome.

Members were in broad agreement that, going forward, it would be appropriate to pause any additional tightening to allow economic developments to unfold. The Bank had been forceful to date in tightening monetary policy, and the full impact was still to come. In addition, there were enough “green shoots” of progress. Allowing time for further progress to occur would recognize the lags in the transmission of monetary policy and balance the risk of over- versus under-tightening.

Members discussed how to communicate this need to pause. They reflected on their previous communication in December, which had indicated Governing Council would consider whether the policy interest rate needs to rise further. That communication had also articulated three developments Council would be assessing:

• how tighter monetary policy is working to slow demand
• how supply challenges are resolving
• how inflation and inflation expectations are responding

They agreed that the December communication conveyed more of a data-dependent, “decision-by-decision” stance about whether to raise the policy rate further. They debated whether that remained appropriate. Through further discussion, they drew a few conclusions:

• Council wanted to convey that the bar for additional rate increases was now higher. If the economy and inflation were to unfold broadly in line with the projection, they agreed they would probably not need to raise rates further.
• Council also wanted to give a clear sense that they would need an accumulation of evidence to determine whether further rate increases would be required to return inflation to the 2% target.
• Members also felt it was important to be clear about the conditionality of any pause. Given inflation was still well above the target, Governing Council continued to be more concerned about upside risks. In its determination to return inflation to the 2% target, Governing Council would be prepared to raise the policy rate further if these upside risks materialized.

Governing Council reached a consensus to increase the policy rate by 25 basis points and adjust its communications to indicate a conditional pause on any further policy tightening. Members also discussed the Bank’s quantitative tightening program. They agreed to continue the current policy of shrinking the balance sheet by allowing maturing bonds to roll off.