Will rate increases really save Canada from high inflation?

After the Bank of Canada’s recent rate meeting, Scotiabank’s Derek Holt is reiterating its forecast of 8 rate increases by the end of 2023. In his opinion, it’s necessary to adjust borrowing costs if we want to normalize inflation. Nevertheless, one noted economist doesn’t think rate hikes will save Canada from price pressures.

“Next year, we’ll definitely see several rate hikes,” – noted Holt.

“We’ve predicted 4 rate hikes during the second half of 2022, and we believe the tightening cycle will start sooner, somewhere in the New Year, or next spring.”

He says Canadian households need time to prepare for it, so the central bank’s first moves will be gradual and measured. However, Holt believes the era of “ultra cheap” financing rates is coming to its end.

On Wednesday, the BoC stopped its quantitative easing program, signalling about possible rate hikes in “the middle quarters of 2022”.

As a result, the Canadian dollar went up sharply, which Holt says will help the Bank.

“I believe it’s necessary,” – he noted on the loonie’s reaction. “If we come anywhere close to the kind of growth numbers we’re expecting and inflation, then such type of tightened financial conditions is necessary.”

“In my opinion, markets are in the driver’s seat right now, while the central bank is dealing with significant credibility challenge.”

Meanwhile, Frances Donald doesn’t think that rate increases will cure the national economy, even suggesting Macklem will need to step back a little from his recent economic outlook.

“The Bank of Canada is telling us that it’s more concerned about inflation and that this is one of the main reasons to raise interest rates sooner,” – noted Donald, chief economist and head of Macro Strategy at Manulife Investment Management.

According to Donald, the problem is that the inflation affecting Canadians is caused by such global issues as port closures in China, tariffs, and droughts in Brazil.

“The kind of inflation the central banks can monitor is a longer-term inflation pushed by higher wages and shelter costs,” – she said.

“My concern is that if the BoC really starts raising rates as aggressively as the markets are predicting, that will hardly help in solving our inflation problem and will only dampen growth further.”

Donald believe the Bank of Canada should rather deliver messages similar to what the European Central Bank and the U.S. Federal Reserve are saying: inflation is transitory, and the price pressures will probably ease sometime in the New Year without any interference.

“I don’t think they can move as fast or as high as the market is expecting,” – she added. “We’ll probably see one or two rate increases next year.”