The Bank of Canada in Ottawa on July 12.Sean Kilpatrick/The Canadian Press
The Bank of Canada is expected to announce another oversized interest rate increase this week, pushing borrowing costs into “restrictive territory,” despite signs that inflation has peaked and the Canadian economy is slowing down.
Bay Street forecasters and financial markets are betting the central bank will raise its overnight rate by 75 basis points Wednesday. That would lift the benchmark rate to 3.25 per cent, a restrictive level where monetary policy acts as a drag on the overall economy.
A smaller, 50-basis-point hike and a larger, 100-basis-point move are also possible, some economists say.
Governor Tiff Macklem and his team have increased borrowing costs four times since March, in a bid to slow the pace of rising consumer prices and prevent Canadians from losing faith in the central bank’s 2-per-cent inflation target. That included a full percentage point increase in July, which was four times the size of a typical rate hike and the largest single move since 1998.
Interest rate changes usually take six to eight quarters to have a full impact. But the Bank of Canada’s aggressive campaign, which has increased the cost of mortgages, business loans and personal loans, is already squeezing the economy.
Home sales and prices have fallen sharply from their peak earlier this year, while preliminary data from Statistics Canada suggests the country’s gross domestic product (GDP) contracted in July. The job market also appears to be cooling, with about 74,000 jobs lost in June and July.
Signs of softening economic growth are unlikely to push the central bank off course, economists say. The rate of consumer price index (CPI) inflation is almost four times the central bank’s target, and officials are wary that high inflation will become entrenched if individuals demand higher wages and businesses set higher prices in a self-reinforcing wage-price spiral.
“By acting forcefully in raising interest rates now, we are trying to avoid the need for even higher interest rates and a sharper slowing down the road,” Mr. Macklem said in an op-ed published in the National Post on Aug. 16, explaining the bank’s decision to front-load its rate hike cycle rather than increase borrowing costs at a more gradual pace. “We know our job is not done yet – it won’t be done until inflation gets back to the 2-per-cent target.”
Several financial institutions, including Royal Bank of Canada and Desjardins, have said the central bank’s rate hikes will likely push the Canadian economy into a recession in 2023.
Mr. Macklem said in July that he believes a “soft landing,” in which inflation comes down without a spike in unemployment or a significant economic contraction, is still possible. But he acknowledged that the path to a soft landing has narrowed and signalled clearly that the bank is willing to cause considerable economic pain to get inflation under control.
This echoes increasingly hawkish comments from other central bankers, most notably U.S. Federal Reserve Chair Jerome Powell. At a meeting of central bankers in Jackson Hole, Wyo., in late August, Mr. Powell said fighting inflation will likely require “a sustained period of below-trend growth.”
“While higher interest rates, slower growth and softer labour-market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain,” Mr. Powell said.
There are signs that headline inflation in Canada has peaked and is starting to come down. The annual rate of CPI inflation dipped to 7.6 per cent in July from a four-decade high of 8.1 per cent in June, largely thanks to falling oil prices.
But domestic inflationary pressures continue to mount. The pace of wage growth is picking up, and measures of core inflation, which strip out the more volatile CPI components such as oil and food, pressed higher in July. There has also been a series of upward revisions to the bank’s favoured CPI-common measure, which suggests domestic inflationary pressures were higher this spring than previously thought.
“Global factors and energy prices falling out of inflation, that’s the low-hanging fruit,” said David Watt, chief economist at HSBC Canada, in an interview.
“But getting domestic inflation back down might be more of a challenge, and [the Bank of Canada] might need to go into that more restrictive territory and put more of a slowdown to the domestic economy in order to bleed out that inflation, because it looks like there might have been more domestic momentum than we anticipated,” he said.
With another rate hike this week a foregone conclusion, speculation has turned to what will happen next. Some economic forecasters expect the Bank of Canada to pause after this rate increase, while others are expecting another 25 or 50-basis-point move in October.
All eyes will be on Wednesday’s rate decision statement for hints about the future and the possible end point, or “terminal rate,” of this interest rate cycle. Most private-sector economists expect a terminal rate of between 3.5 per cent and 4 per cent.
“While we’ve argued October’s meeting could result in a hold, we do not expect the BoC to fully close the door to future rate hikes in the statement,” Taylor Schleich, director of economics and strategy at National Bank, wrote in a note to clients.
“It’s more likely the bank strikes a decidedly more data dependent tone. And assuming the BoC doesn’t explicitly rule out further rate increases, we also wouldn’t be surprised to see them take a page out of the Fed’s book and guide us towards a slower pace of hikes,” he said.
Wednesday’s statement-only announcement will be followed by a speech by senior deputy governor Carolyn Rogers on Thursday.