Policymakers at the Bank of Canada are keeping their cards close to their chest amid growing calls for another interest rate hike to tame a surprise uptick in inflation last month.
The annual inflation rate in April rose slightly to 4.4 per cent, compared with 4.3 per cent in March, Statistics Canada reported Tuesday.
Bank of Canada governor Tiff Macklem, speaking to reporters Thursday after the release of the central bank’s annual financial system review, acknowledged that April’s inflation report was “stronger than expected.”
He maintained, however, that despite an uptick in energy prices and persistence in food inflation, Tuesday’s inflation report showed signs of progress. The bank’s preferred core measures of inflation continued to retreat year-over-year in April, and there were signs of easing in the services sector, he noted.
The Bank of Canada has kept its key rate on hold in two consecutive decisions after a rapid hiking cycle that saw the benchmark rate rise 4.25 percentage points over the course of a year.
Policymakers have said the pause is conditional on inflation returning to the central bank’s two per cent target and left the door open to additional rate hikes “if needed.”
Macklem was asked by reporters Thursday whether the inflationary bump would affect the Bank’s monetary policy plans, but the central bank head would only say that the governing council would look at the inflation data alongside other economic inputs and draw a decision at its next announcement on June 7.
Macklem indicated that overall, the Bank of Canada is encouraged by its progress to date on inflation and said the central bank expects price pressures will continue to ease.
“The reality is higher interest rates are working, inflation is coming down,” he said Thursday.
While Macklem would not comment on the timing or likelihood of additional hikes, he was once again clear that discussion of when the Bank of Canada will cut interest rates is premature.
“We’re using this pause to assess whether we’ve increased interest rates enough to bring inflation back to target. There is no hint of cuts in that statement. It is far too early to be thinking about interest rate cuts,” he said.
Market odds of another rate hike grew after inflation surprise
Money markets continue to expect the central bank will hold steady on June 7, but odds of a hike next month rose to roughly a one in three after the inflation surprise on Tuesday.
Derek Holt, the head of Scotiabank Capital Economics, is among the voices on Bay Street expecting another interest rate increase — and sooner, rather than later.
Holt said in a note to clients on Wednesday that if the Bank of Canada does need to increase its benchmark rate, which sets the cost of borrowing for lenders and their customers, it’s better to do it early.
If business and consumer expectations for inflation remain elevated for longer, it’ll make it that much harder to get price pressures back under control and hit the Bank of Canada’s two per cent target, Holt argued.
“If the BoC doesn’t adopt the crush it, killer mentality, then it may never succeed in getting inflation down to (two per cent),” he wrote.
Holt also said the central bank is willing to surprise the markets with rate hikes, as market odds were wrong about the magnitude of rate increases in three of the eight decisions during the cycle.
Jay Zhao-Murray, an analyst at Monex Canada, said in a note earlier this week that in addition to the headline inflation figure rising in April, the central bank’s preferred measures tracking so-called “core inflation” accelerated on a three-month basis. These figures still cooled on an annual basis.
These concerns, in addition to signs the housing market correction has bottomed and sales activity is on the rise again this spring, could force the Bank of Canada to make an “insurance hike” in June, Zhao-Murray said.
Other economists believe the Bank of Canada will be content to remain on the sidelines in June.
Concordia University professor Moshe Lander told Global News on Tuesday that the central bank could view the April inflation uptick as “just a blip” and wait for more data — particularly concerning wage growth in Canada’s tight labour market — before moving again.
“I don’t think that the Bank of Canada is worried,” he said.
“They understand that (taming inflation is) not a linear progression … there will be bumps along the way.”
RBC economist Claire Fan said in a note Tuesday that the Bank of Canada’s rate hikes to date are now starting to show signs of “weighing on economic growth,” suggesting inflation pressures will continue to ease. RBC expects the central bank’s key rate will remain on hold for the remainder of 2023.
Mortgage stress among risks to financial system
The Bank of Canada’s 2023 financial system review showed the impact of higher rates on Canadian households, with Canadians’ mortgage debt highlighted as one source of stress to the economy.
Higher borrowing costs mean more households are expected to face financial pressure in the coming years and a decline in housing prices has reduced homeowner equity, according to the annual report published Thursday.
The Bank said many Canadians have less financial flexibility after stretching their budgets to get into the housing market by taking on large mortgages with lengthy amortization periods.
“A longer amortization period reduces the size of monthly payments, helping lower debt-servicing costs, but increases the period of household vulnerability because equity is built more slowly,” the Bank stated.
Carolyn Rogers, senior deputy governor at the Bank of Canada, said Thursday alongside Macklem that increasing amortizations was an effective “release valve” for Canadians facing higher mortgage rates.
While about one-third of mortgages have seen an increase in payments compared with February 2022, just prior to the Bank of Canada’s recent rate hiking campaign, nearly all borrowers are expected to face higher payments by 2026.
Mortgage payments could spike as much as 40 per cent in three years for those on variable-rate mortgages with fixed payments, while those with fixed-rate mortgages could see their payments increase by 20 to 25 per cent over 2022 levels.
Rogers told reporters Thursday that averages around how much more Canadians are expected to pay can “sometimes hide extremes,” and that each households increase in payments when they renew their mortgage terms will vary depending on their starting points.
Some households are feeling particularly stressed under the weight of higher rates, while others can draw down on savings accumulated during the pandemic, she said.
Other factors are expected to soften the blow of higher mortgage rates, Rogers said, such as Canadians getting raises or higher paying jobs over that course of their term and having paid down more of the principal amount since their last renewal.
“If the payments increase that you see creates stress in your household budget, you do have a number of ways to mitigate that stress.”
— with files from The Canadian Press
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