The Bank of Canada surprised markets Wednesday by keeping its key lending rate at 0.25 per cent, while putting Canadians on notice that interest rates will eventually rise.

The central bank decided to hold on rates despite surging inflation and a stronger-than-expected economic recovery. Heading into the decision, Bloomberg data showed the implied probability of a hike on Wednesday was approximately 70 per cent.

In its statement, the bank acknowledged slack in the economy has been absorbed but that the Omicron variant of COVID-19 is currently hindering growth.

“We judged that it was appropriate to move forward in a deliberate series of steps,” Bank of Canada Governor Tiff Macklem said during a press conference. “[Wednesday’s] decision is consistent with our deliberate approach we’ve taken throughout this pandemic. And it also reflects the fact that Omicron is weighing on the economy as we speak.

“There’s been a lot of uncertainty, and reopening the economy as the variant continues to reverberate through the economy and mutate has proven complicated. By being clear and deliberate, we’re really trying to cut through the noise so monetary policy is more of a source of confidence and not another source of uncertainty,” he added.

The hold on rates also comes as the bank raised its inflation projections. It now expects consumer price growth will remain near five per cent in the first half of the year, bolstered by ongoing supply chain issues and rising food and commodity prices, before easing to 2.3 per cent in 2023. The bank’s longer-run projections are still anchored on the bank’s two per cent target.

“The bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation,” it said in the statement, while adding that it expects interest rates to rise in the future.

“The Bank of Canada judged that a fresh pandemic wave wasn’t the opportune time to launch into a rate hike cycle, or just wanted to formally end its forward guidance before actually pulling the trigger, but left no doubts that rate hikes are coming,” said Avery Shenfeld, chief economist at CIBC Capital Markets, in a report to clients. 

Another reason that might have factored into the decision to delay hiking, according to Manulife Investment Management Global Macro Strategist Eric Theoret, is that the bank hadn’t previously telegraphed to markets that the output gap had closed.

Many other boxes on the bank’s list, though, had been checked off ahead of the rate decision: the economy has been resilient despite renewed restrictions, the labour market exceeded pre-pandemic levels; and, of course, inflation was running well above the bank’s target range.

Theoret pointed to the fact that monetary policy operates with a lag, so the Bank of Canada could find itself raising rates in the future as the economy is softening.

“The inflation we’re seeing right now is actually the result of monetary accommodation we had throughout most of 2020 and 2021,” he said, adding that the Bank of Canada and U.S. Federal Reserve are playing catch up on the misalignment of where monetary policy is and where it needs to be.

“I think the clouds on the horizon are still a bit concerning. If you look at the consumer, the impact of inflation in terms of real consumption – I think that’s the key piece. With all these signals we’re getting on the economy, price signals and the labour market, that will lag monetary policy and could actually start to bite at a time we start to lose economic momentum in the midpoint to later half of this year.”