Bank of Canada says it can pause rate hikes as inflation set to ‘decline significantly’

Click to play video: '‘Our social cohesion is suffering’: Rising inflation, interest rates costing personal connections'
‘Our social cohesion is suffering’: Rising inflation, interest rates costing personal connections
The Bank of Canada has hiked its benchmark interest rate to 4.5 per cent, the highest it's been since 2007. This is the eighth increase since March 2022. Anne Gaviola explains how the rising cost of living has affected the social cohesion of Canadians, and how the central bank is hinting at pausing rate hikes – Jan 25, 2023

The Bank of Canada delivered another hike to its key interest rate on Wednesday but said this could be the peak for the current tightening cycle as inflation is expected to “decline significantly” in the months to come.

The central bank raised its policy rate to 4.5 per cent in its first decision of 2023, an increase of 25 basis points. This is the highest the Bank of Canada’s key rate has been since 2007.

Wednesday’s decision marks the eighth consecutive time the Bank of Canada has raised the cost of borrowing, hiking the benchmark rate a total of 4.25 percentage points in the past year in an effort to tamp down inflation.

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Raising the key interest rate makes borrowing more expensive in general and forces Canadians and businesses to put more of their budget towards paying down debt, reducing spending demand in other sectors of the economy in hopes of limiting inflationary pressures.

Most economists had expected the 25-basis-point move.

But the central bank said in a statement accompanying the rate hike that it expects to hold the policy rate at its current level while it assesses the impact of its increases to date.

Click to play video: 'What to expect from inflation, interest rates in 2023'
What to expect from inflation, interest rates in 2023

“We’ve raised rates rapidly, and now it’s time to pause and assess whether monetary policy is sufficiently restrictive to bring inflation back to its two per cent target,” Bank of Canada Governor Tiff Macklem told reporters after the announcement on Wednesday.

He added that hold is “conditional” on whether the economy continues to develop according to its forecast, and he made it clear that additional hikes could be in the cards to get inflation back down to the two per cent target.

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Sharp decline in inflation forecast

Headline inflation has cooled from a high of 8.1 per cent in mid-2022, most recently clocking in at 6.3 per cent in December.

The Bank of Canada said in an updated set of projections Wednesday that it expects inflation to “decline significantly” in the months to come, reaching three per cent by mid-2023 and two per cent next year. The central bank had previously expected inflation to hit three per cent by the end of the year.

Here, too, policymakers added a caveat. Macklem acknowledged that the Bank’s forecast for inflation depends heavily on global factors such as energy prices. And while goods prices have shown improvement lately, the stickiness of inflation in the services sector is another risk to the Bank’s outlook, he said.

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“Inflation is still over six per cent. Yes, we are certainly seeing clear evidence … that inflation’s coming down. But we do have to be humble. There are a number of risks out there,” he said.

Macklem clarified that just because the Bank uses a target range of one to three per cent to guide Canadians’ inflation expectations, the central bank won’t be satisfied with inflation hitting three per cent — it will continue to tighten monetary policy until it hits the mandated two per cent goal.

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One-fifth of Canadians say they’re ‘completely out of money’ as inflation bites, poll finds

The pause on interest rate hikes could end if the Bank starts to see an “accumulation of evidence” that inflation and other economic indicators aren’t heading the way policymakers expect, Macklem said.

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Asked by reporters whether interest rates could start to decline, the central bank governor pushed back on speculation amid money markets that a rate cut is coming before the end of 2023.

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“It’s far too early to be talking about cuts,” he said.

Royce Mendes, director and head of macro strategy at Desjardins, said Macklem and his team would likely keep rates on hold for at least the next few months.

“As a result, we expect that this will be the final rate hike of this cycle,” he said.

How will the rate hike hit the housing market?

Wednesday’s decision means the cost of borrowing on many loans such as mortgages in Canada has risen by a cumulative 4.25 percentage points since the start of the central bank’s rate hike cycle last March.

This is significant for those with variable-rate mortgages especially, as those products see the interest on their debt rise immediately in line with the Bank of Canada’s policy rate.

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Shannon Terrell, financial expert with NerdWallet Canada, told Global News that homeowners with variable rates can expect their payments to stay near their current levels through 2023.

Those with fixed-rate mortgages who are renewing into today’s higher interest rate environment might also want to consider shorter-term mortgages of less than five years, Terrell suggests, in hopes of locking in a lower rate when the Bank of Canada eventually starts cutting rates.

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Canadian economics professor on housing market projection for 2023

But she cautioned that Canada isn’t “out of the woods yet” when it comes to inflation, and said Canadians making mortgage decisions ought to watch price pressures for an indication of where interest rates could go.

“If inflation continues the downward trend, future rate hikes may not be necessary. And if we continue to see the rates fall, it actually gives the bank a reason to potentially even lower the rate by a marginal amount. But we’re likely not going to see something like that happen until late 2023,” she said.

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Housing activity has cooled in Canada since the start of the Bank’s current rate hike cycle, with home prices in some markets facing double-digit declines from the peak roughly a year ago.

Speaking alongside Macklem on Wednesday, Senior Deputy Governor Carolyn Rogers said the slowdown in housing has been “in line” with the Bank of Canada’s expectations, though economists at the central bank believe “there is a little bit further to go for housing to come down a bit.”

Despite recent weakness, she said she expects the country’s housing market to “come back” later in 2023 amid strong “fundamentals” such as growing demand from immigration.

Recession still in the cards, Bank of Canada says

Ipsos Public Affairs polling conducted exclusively for Global News this past week showed that 68 per cent of Canadians believe interest rates will rise faster than they can keep up.

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Speaking to reporters Wednesday, federal Conservative Party Leader Pierre Poilievre called the rate hike a “sucker punch” to Canadians, but falsely claimed the decision was made by the Liberal government. The Bank of Canada is an independent institution that leads monetary policy for the country.

Prime Minister Justin Trudeau was also asked Wednesday about the latest rate increase and whether it would affect his policy agenda as Canadians struggle to keep up with rising costs.

He reiterated the government’s stance that it would avoid supports that stimulate inflation and run against the Bank of Canada’s efforts to rein in spending demand.

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Liberal cabinet retreat: Cost of living at forefront of discussions

“By being targeted in our support and by making the kinds of investments that are going to create sustained economic growth for years to come, we can support Canadians without endangering the track that the Bank of Canada’s put us on to reduce inflation,” he said.

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Macklem acknowledged Wednesday that the cumulative rate hikes will strain Canada’s economy and ratchet up the pressure on households, though he maintained it is necessary to slow spending demand and ultimately cool inflation.

“It’s not painless. We’ve raised interest rates forcefully, that has impacted many Canadians. We are seeing that it’s working … we think it will continue to spread through the economy,” he said.

Amid revised economic forecasts, the Bank of Canada continues to expect to see two quarters of near-zero growth in 2023. Macklem said again that the economy could tip into negative territory and end up a recession, but he said it would likely not be as severe as past downturns.

“It could be a mild recession. It’s not a major contraction,” he said.

Many economists have agreed with Macklem and call for a mild or moderate recession amid a global slowdown in growth.

A recession is often defined as two consecutive quarters of negative growth in GDP.

Some have called for a limited impact to Canada’s jobs market, which remains tight at an unemployment rate of 5.0 per cent. Deloitte said in a forecast as recently as last week that job losses could be muted in the recession as businesses hold on to labour for fear they’d be unable to hire staff back after the downturn.

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Macklem cautioned Wednesday, however, that the jobs market is still too tight and will need to “rebalance” before the end of the Bank of Canada’s tightening cycle. If employment remains robust, inflation pressure will likely remain high in services-based sectors, he said.

While Macklem said annual pay raises have likely “plateaued” around the five per cent mark, lessening the inflationary potential of wages, he noted the labour market remains one area the Bank’s policymakers will be watching to see if rates will need to continue to rise in 2023.

“If the labour market doesn’t rebalance, if it remains really tight, and that continues to put upward pressure on prices, that is something we’d have to take into account.”

— with files from Global News’ Anne Gaviola and Reuters

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