U.S. raises its interest rate by 0.75%, but Tiff Macklem says rate increase cycle in Canada will soon be over

Federal Reserve Chair Jerome Powell says U.S. interest rates will go up even higher than initially expected. However, future increases could be smaller.

Talking to reporters on Wednesday after the Fed raised interest rates by 0.75% for the fourth consecutive time, Powell noted that incoming data since their last meeting points to a higher level of interest rates than previously expected.

According to him, it would be appropriate to slow the pace of hikes starting with the next meeting or the one after that. “No decision has been made yet,” – he added. Powell says they still have some ways before rates are tight enough. “It is too early to consider taking a pause.”

Meanwhile, the Bank of Canada is coming closer to the end of its rate increase cycle. However, the Bank’s governor Tiff Macklem says Canadians should expect borrowing costs to grow more.

Inflation is still too high, he explains. At the same time, the national economy is expected to “stall” in the coming quarters, and that puts the BoC in a very difficult position.

“If we don’t act enough, Canadians will keep dealing with the challenges of high inflation. And they will expect persistently high inflation, which will require even more rate increases, leading potentially to a strong recession,” – Macklem noted.

“If we act too much, we may slow the economy more than necessary, and it will have damaging consequences for people’s ability to pay off their debts, for their jobs and businesses.”

The Bank of Canada raised its key lending rate by another 0.50% last Wednesday. The hike was smaller than financial markets had predicted, but it still brought the overnight rate to 3.75%, marking the highest level since the beginning of 2008.

It was the sixth rate increase since March, which makes this cycle one of the fastest in many years. The main question is how far the Bank plans to go. Now, financial markets believe we’ll have two hikes by 0.25% each: in December and January. In this case, the overnight rate will reach 4.25%.

Interest rate increases are already affecting the Canadian real estate market, with home prices falling by about 10% from the peak earlier this year. Spending on other big purchases, e.g. furniture and appliances, is also reducing. The forecast for the broader economy has deteriorated.

In its recent economic forecast, the BoC predicts almost zero economic growth over the next three quarters, and there’s a 50% probability of several quarters of negative growth, which is a standard definition of a recession. That will cause a hike in unemployment.

“We know that this will affect the most vulnerable workers. It will be a difficult period for some. But there’s not really an alternative,” – Macklem tried to explain. “We need a period of low economic growth. We need to get the labour market into a more balanced territory.”

The central bank reduced its inflation forecasts last week, now expecting consumer price index to average 4.1% in 2023, which is 0.5% lower than in the previous forecast. The Bank predicts 2.8% inflation by the fourth quarter of next year, but does not think we can get back to the 2% target until the end of 2024.