Above: File image of Tiff Macklem. Image source: Bank of Canada.

The Bank of Canada raised its base interest rate 25 basis points to 4.5% and said it was now time to pause the rate hiking cycle to assess its impact on the economy.

The Canadian Dollar reacted to the decision and associated guidance by falling against the majority of its peers.

"The BoC has pivoted! Will hold rates until it knows what to do next. Signs that the economy is slowing and front-loaded rate hikes doing their job. Sound familiar? The Fed, and others, are next. Judging by $CAD reaction... market wasn't expecting BoC to be this explicit," says Viraj Patel, a strategist at Vanda Research.

The Pound to Canadian Dollar exchange rate (GBP/CAD) rose sharply in the wake of the decision, going to 1.6599, taking bank payment rates to approximately 1.6110, competitive cash and holiday money rates to ~1.6430 and competitive payment rates to ~1.6530.

The U.S. Dollar to Canadian Dollar exchange rate (USD/CAD) also showed a spike, rising from 1.3350 to 1.3420, taking taking bank payment rates to approximately 1.3040, competitive cash and holiday money rates to ~1.3297 and competitive payment rates to ~1.3378.

Image: Bank of Canada policy interest rate. Source: Bank of Canada.

The Bank of Canada said in a statement the interest rate hike was justified by stronger-than-expected economic growth, excess demand and tight labour markets but added, "there is growing evidence that restrictive monetary policy is slowing activity, especially household spending."

"Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially. As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment are expected to slow," read the statement.

The Bank's forecasts show economic growth will likely stall by the middle of 2023, before picking up again slightly.

Inflation is forecast to come down "significantly" this year and is on course to fall back to the 2% target in 2024.

In this regard, the Bank thinks it's 'job done'.

"If economic developments evolve broadly in line with the MPR outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases," said the statement.

The 25bp increase to the policy rate was well anticipated by the consensus and was therefore a neutral outcome for the currency market, leaving it to the guidance to provide the surprise.

"The statement also pointed to an easing in the 3-month rates of core inflation, and the expectation that overall inflation will come down "significantly" this year due to the energy prices, improvements in supply chains and the lagged effects of higher interest rates," says Andrew Grantham, an economist at Canadian Imperial Bank of Commerce (CIBC).

"Possibly because of greater confidence that inflation is easing, the Bank changed its guidance to state that if the economy evolves as it expects then the policy rate will be kept on hold at its current level," he adds.

Above: GBP/CAD (top) and USD/CAD showing price action following the BoC decision. Consider setting a free FX rate alert here to better time your payment requirements.

"While suggesting they could hike further if required, we expect the next move to be a cut. CAD is understandably weaker after the release," says James Knightley, Chief International Economist at ING Bank.

The Bank said it was prepared to raise interest rates again if inflation data warranted such a response.

But ING says the next move from the BoC is likely to be an interest rate cut.

"Given Canada's high household debt exposure and greater vulnerability to rising interest rates via the mortgage market structure, we think the economy and inflation could slow more rapidly than the BoC is currently projecting. Consequently, we think the next move will in fact be an interest rate cut with the potential first easing coming as soon as late in the third quarter," says Knightley.