This morning the Bank of Canada increased the overnight lending rate a quarter point to 4.75%, marking the highest since 2001.

The hike defied most analyst expectations, but the departure from the conditional pause in January can be attributed to our economy running too hot. While the Bank didn’t release a new set of forecasts in its statement Wednesday morning, it noted “excess demand in the economy looks to be more persistent than anticipated”. This poses a threat to the 2% inflation target for the bank and begs the question as to whether this hike can be seen as a one-off or the start of a new sequence of rate increases. Overall, the Canadian economy proved to be quite strong through the first quarter of 2023 with GDP growth of 3.1%, that coupled with surprisingly strong consumption growth and an uptick in housing market activity, provides the bank enough evidence to conclude that their monetary policy has not been restrictive enough. Looking back to April’s numbers, we witnessed an increase in CPI inflation to 4.4%, the first increase in 10 months. Notably, goods price inflation and service cost inflation is proving stickier-than-expected reflecting strong demand and a tight labour market. This imbalance leads to concerns that CPI inflation could actually get trapped above Tiff and the Bank’s 2% target. Canadian households and businesses have indeed proven surprisingly resilient in the face of higher borrowing cost however this additional rate hike will bring even more pressure to those with debt balances tied to variable rate products. Market participants can expect a more thorough explanation of the bank’s decision tomorrow when Deputy Governor Paul Beaudry speaks in Victoria, B.C., this will be followed by a news conference. On the back of the decision, Canadian 2 year yields surged to 4.471% and the loonie jumped to C$1.3347 per 1 US dollar. The next scheduled date for the Bank to announce any potential changes to the overnight rate is July 12^th, we can also expect the release of the Monetary Policy Report at the same time.