The Bank of Canada announced another oversized interest rate hike on Wednesday and said that it is “prepared to act more forcefully” if needed to bring inflation back under control.
The central bank’s governing council voted to raise the policy rate by half a percentage point – its third interest rate hike this year. That brings the benchmark rate to 1.5 per cent, just a quarter point below the pre-pandemic level.
Bank of Canada has raised its benchmark interest rate to 1.5%. Here’s what that means for Canadians
The bank said that more interest rate hikes will be needed to cool Canada’s overheating economy and to slow the pace of consumer price growth, which hit a three-decade high of 6.8 per cent in April.
“With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the governing council continues to judge that interest rates will need to rise further,” the bank said in its rate announcement statement.
Wednesday’s widely-anticipated move follows rate hikes in March and April, the latter of which was also a half-point increase rather than the usual quarter-point move. This is the first time the bank has announced back-to-back 50 basis point rate increases since beginning fixed-date interest rate announcements in 2000.
After holding borrowing costs at record lows for the first two years of the COVID-19 pandemic, the Bank of Canada pivoted abruptly this spring and is now moving aggressively to make up for lost time and to shore up its credibility as an inflation-fighter. It warned on Wednesday that “the risk of elevated inflation becoming entrenched has risen.”
Higher interest rates are already reverberating through the economy, most notably in the rate-sensitive housing market. The number of home sales across the country fell 12.6 per cent from March to April on a seasonally adjusted basis, while the home price index slid 0.6 per cent, according to the Canadian Real Estate Association.
The central bank faces a “delicate balance” as it tries to slow the economy without triggering a recession, Governor Tiff Macklem said after the last rate decision in April. At this point, however, Mr. Macklem and his team appear to be singularly focused on getting inflation down.
The bank’s comment that it is willing to “act more forcefully” appears to open the door to 75 basis point hikes in the future. Mr. Macklem had previously said that he would not rule anything out, but that a 75 basis point rate hike would be “very unusual.”
“Don’t expect the hawkish rhetoric to let up until inflation starts to trend lower,” Benjamin Reitzes, Bank of Montreal’s director of Canadian rates wrote in a note to clients. “We continue to look for another 50 [basis point] hike in July, but there’s a risk of a 75 [basis point] move if inflation surprises to the high side yet again.”
Central bank economists expect the rate of inflation to move higher in the near term, led by increases in energy and food prices. Inflationary pressures are also broadening out to a wider range of goods and services, making it harder for Canadians to avoid. Nearly 70 per cent of the components of the consumer price index are experiencing inflation above 3 per cent, the bank noted.
Higher interest rates won’t do much to deal with international sources of inflation, which include persistent supply-chain bottlenecks, COVID-19 lockdowns in China, and surging commodity prices following Russia’s invasion of Ukraine.
But higher interest rates do dampen demand in the economy. That can impact domestic sources of inflation tied to the service sector, housing market and ultra-tight labour market. In practice, this happens by increasing the cost of borrowing money, which shows up in things such as interest rates on mortgages, business loans and car loans.
The bank is particularly concerned that inflation expectations will become unanchored from its 2 per cent inflation target. Inflation expectations matter because people set prices and negotiate wages based on how fast they think prices are rising – creating a kind of self-reinforcing cycle.
Despite the string of rate hikes since March, the bank’s policy rate remains low by historical standards and continues to stimulate the economy. Central bank officials have said they intend to get the benchmark rate to a “neutral” level relatively quickly. They estimate that this is somewhere between 2 and 3 per cent.
Ahead of Wednesday’s announcement, markets were pricing in another half-point move in July, then smaller quarter-point moves at each of the bank’s remaining meetings this year. That would bring the policy rate to around 3 per cent by the end of the year.
Some Bay Street economists have argued that this rate hike path is too aggressive, given how much of the Canadian economy is based on real estate and how sensitive Canada’s highly indebted households are to higher borrowing costs.
“Recent economic data has been quite strong on balance, and it’s both easy and appropriate to sound hawkish when both growth and inflation are running hot,” Andrew Kelvin, Toronto Dominion Bank’s chief Canada strategist wrote in a note to clients.
“As we move into the fall, we expect data will begin to show signs of a broader slowdown as higher interest rates begin to bite into growth. The Bank may be able to maintain its hawkish tone into the July meeting, but when growth begins to slow the change in tone could be abrupt.”
Bank officials have said they aren’t on “autopilot.” Whether they stop raising rates once the policy rate reaches the 2 per cent to 3 per cent range will depend on how the economy reacts to higher borrowing costs.
Deputy Governor Paul Beaudry will give a speech on Thursday explaining the bank’s rationale for the decision.
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