Bank of Canada raises its overnight rate by 1% to 2.5% in attempt to restrain record high inflation

On Wednesday, the Bank of Canada raised its key lending rate by as much as 1%, which came as a surprises for many. Such a decision strengthens its attempts to withdraw stimulus before 40-year high inflation stays for long.

Governor Tiff Macklem also warned of more increases. The full percentage point increase is the largest one since 1998. Meanwhile, markets and economists predicted a 0.75% hike.

The unexpected decision shows how strongly officials are afraid of growing inflation expectations, as they decided to act aggressively even with the risk of causing additional economic pain.

“As the economy is obviously in excess demand, inflation keeps going up, and more businesses and consumers expect high inflation to stay for longer, the Governing Council decided to front-load the way to higher interest rates,” – the officials noted in an official statement.

In order to explain the move, policy makers pointed to an economy “clearly in excess demand,” high consumer price increases and growing inflation expectations. The Bank says it will keep raising interest rates and is firm in its decision to bring inflation back to the target level.

However, according to policy makers, front-loading rates will limit economic damage in the long term by decreasing the need to chase growing inflation expectations in the future.

The BoC says “the economic cost of restoring price stability will be higher” in case inflation is entrenched in wage and price expectations.

The 1% gain follows two 0.50% rate hikes in a row seen in April and June, which makes the current tightening cycle one of the most aggressive on record. As a result, today, the rate is in the neutral range, where borrowing costs are neither stimulative nor constrictive.

Prior to this meeting, traders were expecting an overnight rate to go up to at least 3.5% by the end of 2022.

In its monetary policy report, the BoC raised its short-term forecasts for inflation: nowdcf it’s expected to reach about 8% in the middle quarters of this year, then to go down to 7.5% by the end of 2022. Nevertheless, it will probably not go back to 2% until the end of 2024.

Moreover, the forecast for the Canadian economy was also reduced. Now, they believe the GDP will expand by 3.5% in 2022 and by 1.8% next year, as global economic growth slows down and stricter monetary policy affects activity. Earlier, the Bank expected 4.2% and 3.2% respectively.

The central bank added analysis of a new risk model, in which a “self-reinforcing wage hike and price spiral” may appear. The longer the inflation exceeds 2%, the more likely this scenario is.

The Bank also admitted mistakes in its last year’s inflation forecast, mostly explaining it by global factors, but also pointing to national real estate prices.

According to the BoC, housing activity has already weakened significantly from the high pace we’ve seen during the pandemic. It believes home sales and prices will go down next year amid growing interest rates.

To discuss implications of the latest interest rate jump and strategies for variable mortgage holders, join us this Saturday, July 16 at 7:30am for the live interview on Radio Show “Intersection” on FM 88.9, watch live stream at Radio NOVA Toronto channel or listen online at radionovatoronto.ca.

 

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