The increase shows the seriousness of getting price pressures under control.
The governor of the Bank of Canada.
The photo was taken by Blair Gable.
The Bank of Canada raised its benchmark interest rate by a full percentage point, the biggest one-time increase since 1998 when it was fighting to protect the value of the currency during the Asian financial crisis.
Canada's borrowing rate is 2.5 per cent, compared with 1.75 per cent before the recession. The Bank of Canada predicts that inflation will go up to eight per cent this summer, which is too fast for policymakers who want the consumer price index to go up at an annual rate of 2%.
The Bank of Canada said in a statement that surveys show more consumers and businesses are expecting inflation to be higher for longer. It will cost more to restore price stability if that happens.
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Recent data suggests companies and households are starting to see inflation as permanent, and Governor Macklem's crew of policymakers barely tried to hide it.
With the economy in excess demand, inflation high and broadening, and more consumers expecting high inflation to persist for longer, the Bank of Canada decided to front-load the path to higher interest rates.
People lose faith in the ability of central bankers to keep inflation low. If the central bank keeps a lid on inflation, suppliers and workers won't overreact to sudden spikes in commodity prices.
It has been four decades since Canadians have experienced inflation. Macklem was an economist when Paul Volcker was chairman of the United States Federal Reserve. The Canadian decided a demonstration of his resolve was necessary to avoid a repeat of the recession.
According to the Bank of Canada, the neutral rate is between 2% and 3%. Policymakers made it clear that the policy rate isn't done.
Interest rates will need to rise further and the pace of increases will be guided by the bank's assessment of the economy and inflation, according to the statement. The Governing Council is determined to achieve the two-per-cent target.
The Governing Council continues to judge that interest rates will need to rise further
Macklem said he might have to raise the benchmark rate to get inflation under control With prices increasing in the second half of the year, it is more likely that policymakers will have to increase interest rates in order to keep the economy growing.
The decision to front-load the shift to higher interest rates was based on an updated quarterly forecast that startled Macklem and his associates. The highlights are listed.
The consumer price index is expected to increase by eight per cent in the third quarter and 7.5 per cent by the end of the year compared with a previous estimate of 4.5 per cent. The consumer price index will be above three per cent at the end of the decade, according to the Bank of Canada's new assumptions. Inflation is projected to return to target in the year 2024.
Costs and interest rates are going up. The Bank of Canada predicts the country's gross domestic product will expand 3.5 per cent in 2022, compared with an April estimate of 4.2 per cent, and then slow to 1.8 per cent in 2023, compared with a previous forecast of 3.2 per cent. If Macklem can pull it off, it will be a soft landing from higher interest rates. Increases in borrowing costs tend to cause recessions.
Most on Bay Street didn't see a full one-point increase. The benchmark rate in Canada would be lifted by three-quarters of a point if the Bank of Canada followed the Fed's lead.
Macklem and his associates wanted to beat the Fed. The value of the Canadian dollar increases when oil prices go up. Even as international oil prices went above US$100 per barrel, the exchange rate was stable. The lower the currency, the more expensive imports are.
An important factor in determining exchange rates is interest rate differentials. The Bank of Canada is bigger than the Fed and other major central banks. The chair of the Fed will have to confront his own inflation threat when the next Fed policy meeting takes place.
The Bank of Canada said in its new quarterly economic outlook that the housing market is slowing.
The real estate industry is sensitive to interest rates. When the Bank of Canada dropped to almost zero, demand and prices went up, and now the froth in markets such as Toronto is dispersed quickly as borrowing costs rise.
The contribution from housing is the biggest change in the Bank of Canada's forecast for economic growth. Housing subtracted 0.2 percentage point from GDP in the April estimate.
The five-year fixed mortgage rate is at its highest in more than a decade.
There was a lot of evidence that central banks could run their economies hotter than they thought, so they have spent the past decade thinking about the extent to which they test the relationship between employment and inflation. As it is now clear that inflation isn't slowing on its own, the Bank of Canada decided to go with a shock-and-awe increase to show the public it's serious about getting price pressures under control Recent data shows that companies and households are starting to bake expectations of higher inflation into their prices for goods and services. It would require a recession to stop if that spirals out of control. Policymakers hope to prevent a bad outcome by moving aggressively now.
Kevin Carmichael can be reached via email at kcarmichael@postmedia.
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