The Bank of Canada has raised its benchmark interest rate by another 25 basis points, bringing it to levels not seen since 2001 amid fears the decline in inflation “could stall.”
Economists say the latest move is a warning to Canadians not to expect rate cuts anytime soon, and that future rate hikes are not off the table.
The central bank’s key interest rate now stands at 5.0 per cent following back-to-back increases.
Many economists, including Canada’s big six banks, had expected the move amid signs of resilience in the Canadian economy and fears that annual inflation would not fall all the way back to the central bank’s target of two per cent.
Overall inflation has cooled to 3.4 per cent in May from a recent peak of 8.1 per cent in June 2022, but the Bank of Canada’s policymakers have expressed concern that a tight labour market and a resilient economy could make it more difficult to tamp down inflation.
Bank of Canada governor Tiff Macklem told reporters Wednesday that while the central bank’s governing council feels the rate hikes to-date have made “considerable progress” in slowing inflation, “underlying pressures are proving more persistent than expected.”
The central bank now expects inflation will hover around three per cent for the next year before “gradually declining to (two per cent) in the middle of 2025.” This is later than previous expectations that inflation would hit two per cent by the end of 2024.
The Bank of Canada is also worried that progress “could stall,” it said in its release Wednesday, leaving inflation stuck above the two per cent target.
Future interest rate decisions will be taken on a meeting-by-meeting basis, Macklem said.
“We’re taking it one decision at a time.”
Did the Bank of Canada have to hike?
The Bank’s policymakers did consider leaving the key rate unchanged in July, Macklem said, but ultimately decided that not hiking now could mean they’d have to raise rates even higher in the future.
He said the Bank of Canada is trying to “balance the risks” in each scenario.
“If we don’t do enough now, we’ll likely have to do even more. But if we do too much, we risk making economic conditions unnecessarily painful for everybody,” Macklem said.
While Wednesday’s rate hike was widely expected among economists and market watchers, not everyone agrees that the Bank of Canada should have raised its policy rate again.
Craig Alexander, the former chief economist at Deloitte Canada and TD Bank, who now runs an independent shop, says the central bank would have been “more prudent” to leave rates unchanged and let its increases to date take more effect in the economy.
“I think the Bank of Canada has done enough in terms of raising rates. And if they wait and they give it time, they would find that that inflation is going to come down towards their target,” he tells Global News.
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Randall Bartlett, senior director of Canadian economics at Desjardins, told Global News that, going forward, the Bank of Canada will be looking for signs that “sticky” core inflation is cooling, and that the tight labour market and wider economy are showing signs of a needed slowdown.
“When all of these pieces start to come together, I think that’ll give the bank more confidence that it can remain on the sidelines for the foreseeable future,” he said in an interview.
Bartlett expects the Bank of Canada will leave rates unchanged for the remainder of 2023.
CIBC senior economist Andrew Grantham said in a note to clients Wednesday morning that the tone of the Bank’s statement implies the risks are “skewed towards another hike after the summer.”
Alexander believes that additional increases in the realm of 25-50 basis points are still in the cards for this tightening cycle — “they’re fine-tuning interest rates,” he says — but a return to the rapid and oversized rate hikes from the past year is not.
Recession not ruled out despite ‘resilient’ economy
The Bank of Canada also released a new monetary policy report on Wednesday with revised expectations for economic growth.
The central bank now expects gross domestic product (GDP) growth of 1.5 per cent in both the second and third quarters of 2023.
On the year, the Bank expects GDP growth will be stronger than first expected in 2023 and slightly weaker in 2024.
Macklem had previously said that the needed cooldown in demand could result in a technical recession — negative economic growth for two or more consecutive quarters — en route to getting inflation back down to the two per cent target.
Macklem didn’t rule out a recession when speaking to reporters on Wednesday, but he said that, based on the Bank of Canada’s latest projections, “there is a path back to price stability while maintaining growth, so there is no recession.”
While Desjardins is still calling for a mild recession in the first half of 2024, Bartlett notes that the “resilient” economy in Canada, as well as globally, has pushed some economists to remove recession calls from their forecasts entirely.
Desjardins also disagrees with the Bank of Canada about the magnitude by which the economy will bounce back in 2025. The central bank’s monetary policy report calls for GDP growth of 1.2 per cent in 2024 to double to 2.4 per cent annually in 2025.
Bartlett says the recovery from the upcoming slowdown should be more gradual than the “sharp rebound” in the Bank of Canada’s forecast as Canadians with fixed-rate mortgages continue to renew their loans in the higher rate environment.
When could the Bank of Canada cut rates?
The Bank of Canada’s tightening cycle has now seen the policy rate rise 4.75 percentage points since March 2022. The central bank held its key rate steady in two consecutive decisions this year but came off the sidelines last month with a quarter-percentage-point hike.
Macklem reiterated Wednesday that it is “clearly too early to be talking about interest rate cuts.”
BMO chief economist Doug Porter said in a note to clients on Wednesday that the bank is pushing back its timeframe for rate cuts by one quarter. BMO now expects the Bank of Canada to begin trimming its policy rate in the second quarter of 2024.
CIBC’s timeframe for cuts is similar — but Grantham said in his note that the bank is moving its call forward, expecting rates to start falling in April 2024 compared to earlier expectations for June. He cited risks that the Bank of Canada will “overshoot” with another hike in September as making a case for an earlier swing to cuts.
Bartlett said the 25-basis-point hike on Wednesday won’t necessarily have a substantial impact on inflation itself, but rather it will help to “reset expectations” for Canadians about the path for interest rates.
Raising the interest rate increases the cost of borrowing for Canadians, particularly for homeowners renewing their mortgages or those with variable-rate loans that see payments rise in line with the central bank’s benchmark rate.
If Canadians assume that interest rates are likely to stay “higher for longer” — putting off calls for rates to drop — they might be a bit more conservative with their spending, which is exactly what the Bank of Canada is hoping to engineer, he explained.
Wednesday’s rate hike “helped to reinforce those expectations that cuts are not coming soon,” Bartlett said.
“Rates are going to be elevated for the foreseeable future. So households need to be prepared for that.”
Rate hikes not done lightly, BoC officials say
The latest rate hike comes after polling from Ipsos Public Affairs conducted exclusively for Global News shows Canadians are feeling increasingly stressed about the impact of rising rates on their budgets.
Some 71 per cent of Canadians are worried that interest rates will rise faster than they can adjust, the survey released on Tuesday shows.
Bank of Canada officials acknowledged Wednesday that continuing to raise interest rates ratchets up the pressure on Canadians, but stood by the move as necessary to restore price stability. Bringing inflation all the way back down to two per cent helps households plan and make spending decisions with more certainty about what will happen to the cost of living next, they argued.
“We are acutely aware that these decisions have real impacts on Canadians, so we always debate the options and we never make a decision lightly,” said the Bank’s senior deputy governor, Carolyn Rogers, on Wednesday.
Prime Minister Justin Trudeau, speaking from the NATO summit in Lithuania, said the revelation that interest rates were moving even higher on Wednesday was “not the news that any Canadian wanted to receive this morning.”
Trudeau said the cost of living is a challenge facing other global leaders he has gathered with at the summit and he pointed to “targeted support” for Canadians with inflation such as the so-called “grocery rebate” that was delivered to an estimated 11 million households last week as evidence the government is taking the situation seriously.
“The cost of living is a real challenge everywhere around the world with record high inflation, with interest rates continuing to go up,” Trudeau said.
“We are very much focused on supporting Canadians, even as we create great jobs and grow the economy.”
The leader of the Conservative Party of Canada, however, laid the blame for high inflation and the latest interest rate hike at the prime minister’s feet.
Pierre Poilievre said Wednesday that the Liberal government’s spending plans and policies such as the carbon tax “have delivered another uppercut to Canadian families who are drowning in debt.”
NDP Leader Jagmeet Singh, meanwhile, said in a Twitter post that “today’s interest rate hikes puts pressure on working people who are already struggling.”
The federal government helps set the mandate for the Bank of Canada but the central bank makes its monetary policy decisions independently.
Canada holds the most household debt of any nation in the G7, according to a recent analysis by the Canada Mortgage and Housing Corp.
— with files from Global News’s Aaron D’Andrea, Mackenzie Gray
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