This is an account of the deliberations of the Bank of Canada’s Governing Council leading to the monetary policy decision on September 6, 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 Thursday, August 31. The Governor presided over these meetings. Members in attendance were Governor Tiff Macklem, Senior Deputy Governor Carolyn Rogers and Deputy Governors Toni Gravelle, Sharon Kozicki, Nicolas Vincent and Rhys Mendes.

The international economy

Governing Council began by discussing recent global economic developments. Core inflation across many different countries remained elevated, keeping central banks focused on returning to price stability.

US economic growth was stronger than had been anticipated, driven by robust labour markets and continued resilience in consumer demand. Members noted that if this strength persists over time, it could act as a source of demand in the Canadian economy even as domestic demand weakens. Despite this strength, both total and core inflation in the United States had trended down in recent months.

Global growth moderated in the second quarter, mainly due to a significant slowdown in China. Members agreed that the largest impact this development would have on Canada would likely be through its effect on global commodity prices, particularly if the slowdown were to persist. Given ongoing weakness in the Chinese property sector, Governing Council agreed that prospects for growth in China would likely remain uncertain.

Strength in the services sector supported modest growth in the euro area, helping offset weakness in manufacturing. Members noted mixed signals in European economic data, particularly purchasing managers’ indexes. Inflation in the euro area remained a concern, with measures of core inflation still elevated.

Globally, financial conditions had tightened since the July Monetary Policy Report (MPR), and bond yields were higher in most advanced economies, reflecting the increase in real interest rates. International oil prices were roughly US$5 per barrel higher than assumed in the July MPR, representing a potential source of inflationary pressures. Members noted that while growth had been slowing in China, global oil prices hadn’t seen downward pressure as a result. Supply factors seemed to be boosting prices more than demand factors.

The Canadian economy and inflation outlook

Governing Council then discussed the evidence that had accumulated, particularly since the July MPR, about the Canadian economy and the dynamics for inflation.

Members took significant time considering the evolution of household spending in the economy, which slowed markedly in the second quarter as consumer sentiment weakened. Demand continued to weaken for interest-rate-sensitive goods, including housing and durable goods, while demand for services was flat.

Governing Council recalled that consumer spending had been a surprising source of strength in the first quarter. At the time, members considered several potential explanations for this strength. Many of these factors, including savings accumulated during the pandemic and solid wage gains, continued to support the economy. Despite this, the National Accounts data for the second quarter pointed to a significant slowing in domestic demand, with softness in consumption and housing. Members agreed this indicated that earlier increases in interest rates were having a larger effect on the economy.

Members observed that final domestic demand had grown by 1% in the second quarter, with important contributions coming from business investment and government spending. They noted that special factors such as volatility in aircraft imports can have an outsized impact on business investment data. One-off factors held back output in the second quarter. These factors included wildfires, which particularly affected the oil and gas and mining sectors and reduced economic growth by around 0.5 percentage points. As well, strikes in the public sector were estimated to have lowered quarterly growth by about 0.25 percentage points.

The Governing Council also discussed the housing sector. Data showed that while resale activity is stronger than a year ago, higher interest rates had dampened demand more recently, with markets softening. Despite this, members noted that strong underlying demand and ongoing limited supply were continuing to push prices up. Higher borrowing costs were also beginning to weigh on home builders, who reported difficulties in funding construction projects.

Members noted that the labour market remained tight, although most indicators of tightness continued to ease gradually from high levels. Much of the easing in the labour market had come from reduced job vacancies rather than job losses, supporting earlier views that the labour market could rebalance without a large surge in unemployment. Members noted that employment growth had fallen below the rate implied by population growth in recent months.

Governing Council considered the evolution of wages, observing that most measures of wage growth remained in a range of 4% to 5% annually. Given that wage growth tends to be a lagging indicator, members said they would be monitoring whether the gradual easing in the labour market would translate into slower wage growth in the absence of increased productivity.

Members talked about the evolution of household credit growth, which had slowed considerably. They interpreted this as a sign that the impact of earlier interest rate increases was continuing to be felt. Further, Governing Council noted that delinquencies on debt were growing, albeit from still low levels. They saw the slowing of household credit growth as affecting a wider range of borrowers. Members noted that business credit growth was also showing signs of easing, but that these data are volatile.

Discussion then turned to recent developments and the outlook for inflation. Members noted that, while total consumer price index (CPI) inflation had been progressing roughly as projected in the July MPR, inflation remained generalized and reflective of ongoing, broad-based pressures. Specifically, the shares of items in the CPI basket rising at an annualized pace greater than both 3% and 5% remained far above pre-pandemic averages. Members welcomed data showing that these shares were declining but expressed concern that they were still too high.

Looking at specific components of the CPI, Governing Council noted that shelter costs, including mortgage interest costs, were contributing importantly to inflation. Members also noted tentative signs, based on three-month data, that components such as food should start to see slower inflation in coming months. However, recent higher prices for oil and gasoline would drive headline inflation higher than its current level over the next few months before it is expected to gradually move back down.

Given this backdrop, Governing Council members agreed that they would focus especially on gauging whether momentum in underlying inflation was easing. Data showed little progress on core inflation since the July interest rate announcement, with many measures proving to be sticky. Both year-over-year and three-month measures of core inflation had settled around 3.5%, suggesting little near-term downward momentum in core inflation.

More generally, members agreed that the balance between economic supply and demand would become more important in determining future core and total inflation. This is because the impact of base-year effects will decrease and the large decline in commodity prices will drop out from the inflation calculation.

Considerations for monetary policy

Governing Council members reflected on how economic developments could affect monetary policy. They considered the situation they faced in their July meeting, when they agreed to raise the Bank’s policy rate by 25 basis points to 5%. At that time, both demand and inflation were more persistent than had been expected. Governing Council considered two interpretations of the situation, both of which could be true to some extent:

• It was possible that not enough time had passed for policy to have a sufficient impact on both demand and inflation.
• It was also possible that monetary policy was not yet restrictive enough to slow demand and relieve inflation pressures.

Members agreed that data since their last decision had shown more clearly that demand was slowing, and excess demand was diminishing as monetary policy gained traction. In particular, demand had levelled out in several industries in the services sector, suggesting that the impact of higher interest rates had broadened. Governing Council noted that the quarterly profile of growth in gross domestic product had been choppy, with a weak fourth quarter last year, a strong first quarter in 2023 and a weak second quarter. But the economy appeared to have entered a period of softer growth. Members also noted that the full impact of more recent policy tightening had yet to be felt.

At the same time, Governing Council agreed that the lack of progress in underlying inflation remained a significant concern. Members weighed the possibility that high core inflation could persist even as evidence accumulated that restrictive monetary policy was slowing demand. They discussed how much wage growth was reducing the downward momentum in core inflation. Members still view annual wage increases in the current range as inconsistent with achieving price stability without a large increase in productivity.

Members discussed the dynamics of company price-setting behaviour, while acknowledging that they had little recent data to work with. They noted that the increase in the size and frequency of price changes when inflation was rising may have contributed to a faster pass-through of input prices by companies. However, it was not clear that the reverse would occur to the same degree when inflation was falling. Members said they expected that the evolution of demand and the re-establishment of competitive forces would be critical in affecting price-setting behaviour.

Governing Council acknowledged that they had received relatively little new information about inflation expectations and company price-setting behaviour since July, compared with the information they had received on output. They agreed that more data will be especially helpful in determining whether the slowing demand would translate into reduced inflationary pressures.

Members noted that they could choose to be patient, receive more data and see whether the evidence showed that interest rates were high enough to return inflation to target. However, they recognized that policy might not yet be restrictive enough and that, by waiting to act, they ran the risk of having inflationary psychology become entrenched in Canada. This would mean they would need to tighten policy even further in the future.

The policy decision

Governing Council reached a consensus to keep the policy rate at 5%. They agreed this was the appropriate decision to balance risks of over- and under-tightening. Economic data showed clearer indications that policy was gaining traction and demand was slowing, and they recognized that the economy will still feel some further impact from past policy tightening.

Discussion then turned to how best to communicate the decision. Members agreed:

• on the need to stress their ongoing concern about the lack of progress in slowing core inflation
• to emphasize their readiness to raise interest rates further if needed
• that, given the uncertain path forward for core inflation, tighter policy should remain a potential option until they see convincing evidence that slowing demand is translating into reduced core inflationary pressures

They also considered the possibility that their decision could be misinterpreted as a sign that policy tightening had ended and that lower interest rates would follow. They agreed that they did not want to raise expectations of a near-term reduction in interest rates, given that they only considered keeping the policy rate where it is or raising it further. They decided to stress that they will pay close attention to the evolution of data as they balance the risks of over-tightening and under-tightening monetary policy.

Governing Council will continue to focus on the assessment of the dynamics of core inflation and the outlook for CPI inflation. In doing so, members agreed that they will continue to evaluate whether the following indicators evolve in a direction that is consistent with achieving the inflation target:

• excess demand
• inflation expectations
• growth of labour costs
• company price-setting behaviour

Governing Council also reviewed the Bank’s quantitative tightening program and agreed to continue the current policy of normalizing the balance sheet by allowing maturing bonds to roll off.