The Bank of Canada on Wednesday raised its policy interest rate -- the target for overnight lending rates -- by 25 basis points to 4.75 percent from 4.50 percent after taking a"conditional" pause for a second straight meeting in April during the current tightening cycle that began in March last year aimed at bringing elevated inflation back to target.

The move came as a surprise to most market participants who had anticipated no action in June and a hike by 25 basis points in July. Governor Tiff Macklem had repeatedly said that it was a"conditional pause" and that the bank would be prepared to raise rates further if it believed it was necessary to do so to get inflation back to target.

The bank has now tightened rates by a total of 450 basis points (4.50 percentage points), jacking up the key rate through nine increases from its record low of 0.25 percent.

The domestic labor market remains tight and economic growth has been resilient despite higher borrowing costs. Higher immigration and participation rates are expanding the supply of workers but new workers have been quickly hired, reflecting continued strong demand for labour, the bank said

Demand for services continues to rebound while spending on interest-sensitive goods have increased and housing market activity has picked up. Goods price inflation increased, despite lower energy costs. Services price inflation remained elevated. The annual inflation rate stands at 4.4 percent, above the bank's 2 percent target.

To sum up the latest economic climate, the bank said,"Overall, excess demand in the economy looks to be more persistent than anticipated."

Monetary Policy Was Not Sufficiently Restrictive

"Based on the accumulation of evidence, Governing Council decided to increase the policy interest rate, reflecting our view that monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2 percent target," the bank said in a statement.

The bank stopped saying that it remains prepared to act further if needed.

"Quantitative tightening is complementing the restrictive stance of monetary policy and normalizing the bank's balance sheet," it noted.

To Watch Excess Demand, Inflation Outlook, Wages, Pricing

Looking ahead, the bank said,"Governing Council will continue to assess the dynamics of core inflation and the outlook for CPI inflation. In particular, we will be evaluating whether the evolution of excess demand, inflation expectations, wage growth and corporate pricing behaviour are consistent with achieving the inflation target."

This compares to its statement released in April:"Governing Council continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed to return inflation to the 2 percent target."

The bank largely maintained its near-term outlook that CPI inflation will"ease to around 3 percent in the summer (from June to August)" as lower energy prices feed through and last year's large price gains fall out of the yearly data. In April, the bank said it expected CPI inflation to fall quickly to around 3 percent in the middle of this year.

BoC Warns: Inflation Could Get Stuck Above 2 percent

"However, with three-month measures of core inflation running in the 3.5 percent to 4 percent range for several months and excess demand persisting, concerns have increased that CPI inflation could get stuck materially above the 2 percent target," it warned.

The bank is scheduled to announce its next monetary policy decision on July 12, when it also provides medium-term growth and inflation forecasts and risk analysis in its quarterly Monetary Policy Report.

"If the data remain firm over the coming few weeks, another 25 bp hike in July looks likely," Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets wrote in a report."We'll get more details on the decision from Deputy Governor Beaudry tomorrow when he delivers the Economic Progress Report."

Among key, the Labour Force Survey for May, due on Friday, is forecast to show employment grew 20,500 following a stronger-than-expected rise by 41,400 in April. The unemployment rate is seen edging up to 5.1 percent from 5.0 percent.

Resilient Economic Activity Amid Higher Interest Rates

Canada's gross domestic product grew an annualized 3.1 percent in the January-March period on relatively mild winter and resilient consumer spending, rebounding from a 0.1 percent contraction in the final quarter of 2022. It was above the early estimate of 2.5 percent and the BoC's 2.3 percent forecast made in April. It is also the highest growth for the quarter among the Group of Seven major economies.

The flash estimate for April GDP by Statistics Canada is a 0.2 percent increase despite the public sector strike in the second half of the month, indicating underlying momentum in the economy is solid.

Total consumer prices rose 4.4 percent on the year in April, ticking up from 4.3 percent in March for the first increase in 10 months. It is still slower than 5.2 percent in February and the recent peak of 8.1 percent recorded in June 2022.

In its April policy decision, the bank said it"expects CPI inflation to fall quickly to around 3 percent in the middle of this year and then decline more gradually to the 2 percent target by the end of 2024."

After holding policy steady in March and April, the Bank of Canada is once again expected to make no change to its 4.50 percent policy rate.

Canada's central bank, the Bank of Canada (BoC), announces its monetary policy with regard to interest rates eight times a year. The announcement conveys to the financial markets and investors what, if any, changes in policy might be. The main focus is the target set for the overnight rate. Policy is framed around keeping the annual rate of inflation as measured by the consumer price index (CPI) within a 1 percent to 3 percent range and close to the 2 percent midpoint over the longer-run. To this end, the BoC also monitors an adjusted measure of the CPI that excludes a range of volatile categories in order to get a better handle on underlying trends.

Bank of Canada determines interest rate policy at eight meetings during the year and they are an influential event for the markets. Prior to each meeting, market participants speculate about the possibility of an interest rate change. A post-meeting statement is issued after each meeting. Unlike the Federal Reserve, there are no post-meeting minutes. The Bank has an inflation target range of 1 percent to 3 percent with specific focus on the 2 percent midpoint.

Although the Bank monitors many economic indicators, as indeed all central banks do, the Bank converted its inflation barometer for operational purposes to a consumer price index measure that subtracts eight volatile components to better reflect core inflation. It also takes the foreign exchange rate for the Canadian dollar into its monetary policy decisions.

Monetary policy goals are to aid and abet solid economic growth along with rising living standards. To achieve these goals, inflation is kept low, stable, and predictable. The inflation control target is at the heart of Canadian monetary policy that the Bank and the Government have established. The level of interest rates and the exchange rate determine the monetary environment in which the Canadian economy operates.

The level of interest rates affects the economy. Higher interest rates tend to slow economic activity; lower interest rates stimulate economic activity. Either way, interest rates influence the sales environment. In the consumer sector, few homes or cars will be purchased when interest rates rise. Furthermore, interest rate costs are a significant factor for many businesses, particularly for companies with high debt loads or who have to finance high inventory levels. This interest cost has a direct impact on corporate profits. The bottom line is that higher interest rates are bearish for the financial markets, while lower interest rates are bullish.