The Bank of Canada’s strategy of rapidly increasing its key interest rate in an effort to tackle skyrocketing inflation will likely trigger a recession, a new study from the Canadian Centre for Policy Alternatives (CCPA) says.
The research institute says if the central bank aims to bring inflation down from 7.7 per cent to its two per cent target by quickly raising rates, it could cause significant “collateral damage,” including 850,000 job losses.
It adds that the central bank has had a zero per cent success rate with this approach, noting that a 5.7 per cent drop in the inflation rate has happened three times over the last 60 years, each time after big rate hikes and accompanied by a recession.
The CCPA is calling for a new policy on inflation targeting to reduce that risk.
Jennifer Lee, senior economist at BMO Capital Markets, who is expecting a 0.75 percentage point interest rate increase from the Bank of Canada this month, said the swift and aggressive hikes will “for sure” cause a significant slowdown in economic growth.
“Whether or not it’s going to be an official recession remains to be seen, but clearly a significant slowdown,” she said.
She also said there are few alternatives that the central bank has at its disposal right now to tackle inflation.
“Rate hikes are needed right now — larger ones — to slay this inflation monster sooner rather than later,” she said.
David Doyle, head of economics at Macquarie Group, who is also expecting a 0.75 percentage point hike, is forecasting a recession in 2023 in both Canada and the United States.
“We expect the contraction to be greater in Canada due to its more severe structural imbalances, such as housing investment and consumer debt levels,” he said.
Canada is already experiencing a slowdown in economic growth and even seeing layoffs in some sectors, like technology.
Statistics Canada said last week it expects to report a GDP contraction of 0.2 per cent for the month of May amid weakness in the resource, manufacturing and construction sectors.
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In its study, the CCPA said the Bank of Canada could potentially reduce the risk of sending the economy into a recession by adjusting its target inflation rate to four per cent. The study highlighted how the bank has successfully avoided a recession when it has aimed for smaller reductions in inflation, allowing the bank to bring in smaller rate increases over a longer period.
However, Doyle said raising the inflation target to four per cent would be a “bad idea.”
“It would damage the Bank of Canada’s credibility and independence and create more uncertainty,” he said. “It would also increase the risk of a severe downside scenario, where there is a de-anchoring of consumer and business inflation expectations.”
The CCPA study comes a day after the Bank of Canada released two quarterly surveys which revealed consumers and businesses expect inflation to stay high for several years, further increasing the odds of a 0.75 percentage point interest rate hike this month.
As for how long it might take to even reach the central bank’s two per cent inflation target, BMO’s Lee said we’ll likely see three per cent inflation by end of the 2023, with two per cent more a 2024 or 2025 possibility.