‘Pressing need’ for Bank of Canada to raise interest rates amid inflation surge

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Bank of Canada receives renewed mandate
The federal government has announced changes to the Bank of Canada's mandate. Business correspondent Anne Gaviola offers her insight on what the changes could mean for interest rates, inflation, and housing – Dec 14, 2021

The likelihood of an interest rate hike from the Bank of Canada next week is growing as record levels of inflation and high housing prices coincide with an anticipated economic rebound from the Omicron wave of the pandemic, some economists say.

Scotiabank Economics said in a note to investors Wednesday that it expects the Bank of Canada to raise its key overnight rate by 25 basis points to 0.5 per cent at its next meeting Jan 26.

This would be the first of multiple interest rate hikes over the course of the year, senior economist Jean-Francois Perrault forecasts, with rates hitting two per cent by the end of 2022.

While the Bank of Canada signalled at the end of last year that interest rate increases were likely for 2022, it had pegged possible hikes towards the middle of the year.

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But Perrault said in his note that the central bank could be forced to act sooner than anticipated after Statistics Canada reported on Wednesday that the annual rate of inflation hit 4.8 per cent in December — the highest level in 30 years.

“Despite a clear, but temporary, negative impact of Omicron on economic activity, it is clear that inflationary pressures are larger than earlier assessed and require a more robust monetary policy response,” he wrote.

A 'pressing need' for higher rates

James Orlando, a senior economist with TD Economics, told Global News in an interview that conditions are right for an interest rate hike in the near future.

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“The Bank of Canada is in a position right now where inflation is at this uncomfortable level, where the economy is hot, where we’re likely going to bounce back strongly from this Omicron time period,” he said.

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“There really is a pressing need for the Bank of Canada to raise interest rates.”

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Orlando also believes the hike will start with 25 basis points, noting that after nearly two years of rock-bottom interest rates tied to the pandemic, the central bank won’t “want to shock people.”

Though markets have built in an interest rate hike on Jan. 26, Orlando says there is a possibility the bank will hold off until its March announcement to wait for the Omicron wave to recede and see how businesses bounce back.

“But with everyone expecting it, the question for the Bank of Canada is, why should they wait?” he asks.

Stephen Tapp, senior economist at the Canadian Chamber of Commerce, agrees.

“My expectation is that, certainly, a rate hike is on the table next Wednesday,” he tells Global News.

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He and Orlando said the Bank of Canada would be able to tie an interest rate hike to a monetary policy report due out the same day. Both noted the increase could wait until the March decision if the governors are feeling skittish about the Omicron recovery, but a warning of a looming increase would at least be in the cards for next week.

Tapp says inflation is having a two-pronged effect on businesses right now. Not only are their costs rising due to more expensive goods, but an anticipated need to increase wages in 2022 to cover inflationary pressures will continue to affect their bottom lines.

Can the Bank of Canada solve the 'inflation puzzle?'

While the central bank might be feeling the pressure to raise interest rates to dampen inflation, some of the causes of surging prices could well be out of its hands.

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“There is little that the Bank of Canada can do to address the biggest part of the inflation puzzle, and that is the pandemic-induced supply chain disruptions,” says Tu Nguyen, economist with accounting firm RSM Canada.

Nguyen and most other economists who spoke to Global News this week said inflation could remain around the five per cent mark for the next few months but eventually come back down toward three per cent by the end of the year, closer to the upper bound of the Bank of Canada’s targeted range.

Also putting pressure on the Bank of Canada to act are record high housing prices.

Orlando says that Canada could see “further housing market acceleration” if the Bank of Canada doesn’t start to raise its overnight lending rates.

“As house prices go up, people get bigger and bigger mortgages, they lever themselves up to uncomfortable levels.” he says. “And so you just add so much more vulnerability to the economy.”

Click to play video: 'How inflation could impact the housing market in 2022'
How inflation could impact the housing market in 2022

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