Bank of Canada raises its policy rate by 1% to tame inflation
REAL ECONOMY BLOG | July 13, 2022
Authored by RSM Canada
The Bank of Canada announced a 100-basis-point rate hike on Wednesday, the largest increase since 1998, in an attempt to restore price stability amid rising inflation expectations and wage growth.
The announcement brought the policy rate to 2.5%. We now expect a 75 basis-point hike at the September meeting and a more moderate hike in December, which would raise the policy rate to between 3.5% and 4% by the end of the year.
With this latest hawkish move in a rate cycle that began in January, the Bank of Canada is in the midst of one of its fastest tightening cycles ever. The move is meant to induce a shock to the system, to tame long-run inflation expectations, which began to inch up this summer.
Inflation has been rising and persistent for about a year, with price increases becoming broad-based across categories of goods and services. Inflation is now expected to stay near 8% for the coming months. All measures of core inflation are at or above 4%, well above the central bank’s 2% target, and increasing.
The Bank of Canada’s primary concern is that inflation becomes entrenched in wage setting and price expectations, which will be difficult to reduce in the long run.
It does not help that these expectations are rising. In addition, the Business Outlook Survey pointed to broad wage growth at a higher rate than cost-of-living adjustments.
With Canada’s unemployment rate at its lowest point since 1976, the year that the data collection began, the labour market is clearly tight. In addition, there is an enormous amount of excess demand in the economy, consumer spending remains strong and business investments are solid.
All these conditions set the stage for more forceful actions to cool the economy, and the central bank is acknowledging that need.
The housing sector will bear the brunt of the rate hike and be a drag on growth. Higher mortgage rates will deter many buyers. While the housing market was overheated, housing sales have been on the decline since the first rate hike in March.
In addition, construction projects might have to be delayed or canceled altogether because of higher rates, which pose other questions on the housing supply and affordability in Canada.
The dramatic hike follows the Federal Reserve’s move last month, as the United States faces even more out-of-control inflation, which reached 9.1% in June, as well as a loss of investor confidence.
As unsettling as this news is for consumers and businesses, an economy-wide recession is still unlikely this year. Certain industries, such as the housing market which has already slowed, will most likely go into decline. But overall, the indicators of the job market, businesses and consumers all point to a healthy economy. A slowdown, however, is a certain and a necessary tradeoff to restore price stability.
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This article was written by Tu Nguyen and originally appeared on 2022-07-13 RSM Canada, and is available online at https://realeconomy.rsmus.com/bank-of-canada-raises-its-policy-rate-by-1-to-tame-inflation/.
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