Bank of Canada due for ‘oversized’ 50-basis-point interest rate hike: economist

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Tips to prepare for higher interest rates
Canadians have grown accustomed to penny pinching and that’s expected to continue as interest rates climb even higher. Personal finance expert Rubina Ahmed Haq has tips to that will save you money – Mar 24, 2022

The Bank of Canada is likely to hike its key overnight rate by half a percentage point on Wednesday, the Conference Board of Canada’s chief economist says, as the think tank’s economic forecast predicts home prices could start to drop next year.

Pedro Antunes tells Global News he expects the central bank to double its key overnight rate to one per cent at its announcement on Wednesday with an “oversized” increase of 50 basis points.

He joins the growing chorus of economists and market forecasters who are now widely expecting an interest rate hike of half a percentage point, the first since May 2000.

Back then, the nominal neutral rate — the level of interest that allows full productivity and keeps inflation on target — was around five per cent. Today, the Bank of Canada estimates the nominal neutral rate to be between 1.75 per cent and 2.75 per cent.

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“A 50 (basis point) hike will do a lot more to cool the economy down today than it did back then,” said Desjardins’ head of macro strategy, Royce Mendes, in a note.

Mendes also says that the Bank of Canada will likely slow the pace of its monetary policy tightening after April and expects “further rate hikes to come in measured steps.”

“That would leave the overnight rate at 2.00 per cent at the end of the year,” he said.

Meanwhile, TD’s chief Canada strategist, Andrew Kelvin, expects the central bank to lift the overnight rate to 2.50 per cent by the end of the year.

Antunes says the move would follow similar rumblings from the U.S. Federal Reserve about a 50-basis-point hike as central banks around the world attempt to get global inflation under control.

Antunes spoke to Global News Tuesday following the release of the Conference Board of Canada’s latest economic forecast in a report titled “Normalcy Out the Window.”

The combination of the war in Ukraine, COVID-19 uncertainty, rising interest rates and rampant inflation has made the latest board’s latest forecasts the most complex Antunes has seen in his career.

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“As Yogi Berra once said, the future ain’t what it used to be,” he says.

“I’ve been in this business of forecasting for many years now and I can’t think of another time when there’s been just so much chaos going on, really, to try and get a handle on where we think the economy is going.”

Economic growth could slow in 2023

For instance, the Conference Board report notes there’s “considerable risk” around Russia’s invasion of Ukraine, which “destabilizes a world that had been hoping for an improvement in the COVID-19 story.”

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But despite the war putting inflationary pressures on food and gasoline prices, Canada’s economy stands to gain from the ongoing war as sharp rises in commodity markets will be a “massive boon” for the country’s agricultural and energy producers, Antunes says.

Click to play video: 'How war in Ukraine is threatening the global food crisis'
How war in Ukraine is threatening the global food crisis

Overall, the Conference Board expects Canada’s gross domestic product to grow by four per cent in 2022 before falling off slightly with a 3.3 per cent increase in 2023.

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Though the board notes that many Canadians racked up significant savings over the past two years of the COVID-19 pandemic, surging gasoline prices could dampen some of the fervent spending this summer.

Demand for road trips, for example, appears to have “abated,” Antunes says, as motorists feel the pinch at the pumps.

While it could take up to 18 months before higher interest rates have a material impact on prices and Canada’s economy, Antunes says the central bank will need to deliver a higher rate hike on Wednesday to help get consumer and business expectations back under control.

When inflation expectations become unmoored, the risk is that wages will spike in response, putting pressure on businesses to then hike prices. That endless cycle of inflation and wage growth is what the bank is trying to avoid, Antunes says, by sending a message to the public that it will act to tamp down on inflation.

“It’s really trying to maintain its credibility that inflation will be contained and the bank has the tools and the wherewithal to do that,” he says.

“It’s a real challenge for the bank just to make sure that people continue to believe that we are going to see inflation return back to that two per cent target.”

But the Conference Board report also warns that Canadians with high debt levels could start to feel the pinch if the central bank enters a more aggressive monetary tightening cycle. Antunes notes many Canadians took their pandemic higher savings and put them into the housing market, making these new mortgage holders vulnerable to rate hikes.

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“With the nominal household debt-to-disposable income ratio reaching a record level in the fourth quarter of 2021, higher interest rates could spell trouble for heavily indebted Canadians,” the report reads.

“We still expect the consumer to lead the way for the Canadian economy, but the combination of rising inflation and higher interest rates could make it a bumpy ride.”

How will the housing market react to rising rates?

The Conference Board report also suggests that Canada’s hot housing market could be cooling, and potentially heading for a correction.

The think tank points to rising interest rates, policy adjustments from the feds and other levels of government and changes in consumer attitudes as taking some of the gas out of the housing market.

Click to play video: 'Will interest rate changes temper the housing market?'
Will interest rate changes temper the housing market?

“Following years of outsized gains, we think this could finally be the year when Canada’s housing markets slow,” the report reads.

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Following 22.5 per cent growth in the aggregate resale home price last year, the Conference Board is projecting eight per cent growth in resale prices in 2022 as cooling takes effect in the second half of the year.

The board goes on to project a six per cent price drop in 2023, with the risk of a “sharper correction” if real estate investors sell their units into an easing market.

BMO senior economist Robert Kavcic told Global News in late March that a series of rate hikes, combined with government measures aimed at cooling the housing market, could see home prices could drop as much as 10 per cent over the next couple years.

He called rising interest rates “the single biggest measure we can take here to cool down the pace of home price growth and inflation more broadly.”

One of the biggest factors that could play into housing affordability is the anticipation of more supply coming onto the market, Antunes says.

The report calls builders’ efforts to ramp up the supply of housing starts a “Herculean effort” with a record number of housing starts recorded in November 2021 as the industry grappled with supply chain constraints and labour shortages.

The federal government also stated its ambitions to double the annual number of new units in Canada to 400,000 per year over the next decade.

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“A lot of that has been held up. It’s been difficult to get the person power in the construction industry to finish a lot of those projects. But it is coming,” he says.

The Conference Board report’s title notwithstanding, Antunes does think there are signs of the housing market rebalancing after two years of rampant growth.

“With interest rates coming up, with normalcy coming back to the economy, perhaps demand easing up as well and helping the market kind of rebalance to something more normal,” he says.

“We just think it’s been way too frothy over the last two years.”

— with files from the Canadian Press

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Federal housing money may not cool red-hot market

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