The Bank of Canada hiked its key interest rate to 0.5 per cent in an effort to “take some steam” out of the economy and tamp down on surging inflation, but economists are warning that high prices will remain a regular part of life for months to come.
The overnight rate target will rise 25 basis points, the central bank announced Wednesday, up from the floor of 0.25 per cent it held for much of the COVID-19 pandemic. It’s the central bank’s first rate hike since October 2018.
In a statement accompanying the decision, the Bank of Canada said the war in Ukraine is “a major new source of uncertainty” that is driving prices higher on oil and other commodities.
“This will add to inflation around the world, and negative impacts on confidence and new supply disruptions could weigh on global growth. Financial market volatility has increased. The situation remains fluid and we are following events closely,” the bank wrote.
The bank had signalled it would use higher interest rates to tamp down on surging inflation, which hit a more than 30-year high of 5.1 per cent in January — well above policymakers’ stated target of two per cent.
Though the central bank said it intends to use its key interest rate to keep expectations for inflation “well-anchored,” it cautioned that global pressures will continue to push prices higher in the months to come.
The Bank of Canada said in a monetary policy report accompanying its January rate announcement that while it expected inflation to remain around the five per cent mark through the first half of the year, it forecast pressure would ease and annual inflation could drop to around three per cent by the end of 2022.
The bank is now cautioning that fresh pressures, including the war in Ukraine, are likely to make inflation worse before it gets better.
“All told, inflation is now expected to be higher in the near term than projected in January,” it wrote.
Inflation impact of rate hike won't be immediate
Beata Caranci, chief economist at TD Bank, told Global News this week that Wednesday’s interest rate hike will not have an immediate impact on headline inflation figures, but consumers could expect some relief before the end of the year.
Even as supply chain constraints show signs of easing in markets across the world — one of the main causes of surging inflation at the end of 2021 — demand driven by the rebounding economy and stronger household buying power will offset much of the relief on the supply side, she said.
Solid GDP figures released on Tuesday confirmed to the bank that the “economic slack” from the COVID-19 pandemic has been absorbed. Strong global demand, increased activity in the housing market and a rebound from the Omicron slowdowns in January could combine for a stronger first quarter of the year than first projected, the central bank said.
Hiking interest rates raises the costs for Canada’s major financial institutions to borrow from the central bank, costs that are then reflected in higher lending rates and certain loans such as variable-rate mortgages.
In response to the Bank of Canada’s interest rate decision, RBC announced Wednesday it’s raising its prime lending rate to 2.7 per cent, up from 2.45 per cent, as of Thursday. Other Canadian banks are expected to follow suit.
Tu Nguyen, economist with RSM Canada, said in a statement that inflation could prove “difficult to tame” as global supply chain disruptions and surging oil prices are well outside the bank’s purview.
“What the rate hike can do is help anchor long-run inflation expectations, which have begun drifting from the two per cent target,” she said.
Raising interest rates can help to “rebalance” the supply and demand equation and dampen consumer spending, Caranci said, but she added that inflation is “sticky” in many areas of the economy and can often ease over a longer horizon.
Canada’s housing market, she offered as an example, is likely to remain hot through much of 2022 as inventory remains low.
Caranci noted that high prices on shipping contracts, many of which have longer lead times, are also going to take roughly two quarters to come back down.
“I think that’s more of a second half of the year story,” she said on easing inflation.
Where does the bank go from here?
One step up is not the last movement the Bank of Canada is likely to make this year. The governing council wrote Wednesday that “interest rates will need to rise further” amid an expanding economy and rising inflation.
CIBC chief economist Avery Shenfeld also said in a note Wednesday morning that the rate hike is the bank’s first step towards “taking some steam out of the economy.”
He projects three further rate hike increases of 25 basis points in the bank’s subsequent announcements before a “pause” at 1.25 per cent for the remainder of 2022.
In a note, BMO’s managing director of Canadian rates Benjamin Reitzes also forecast another 25 bps hike in six weeks.
The Bank of Canada’s next interest rate decision is set for April 13.
— with files from The Canadian Press