Bank of Canada hikes interest rate by 0.5% for first time in 22 years

The Bank of Canada raised its benchmark interest rate by a half point on Wednesday and said inflation will remain above its comfort zone for the rest of the year.

You need to know what this is.

0.5% biggest rate hike since 2000

The benchmark interest rate was increased by the Bank of Canada to one per cent, the biggest increase in borrowing costs since 2000. The central bank adjusts policy at a quarter-point at a time.

Quantitative tightening, or QT, is the opposite of quantitative easing, and was initiated by the central bank.

The central bank created hundreds of billions of dollars to purchase bonds. It stopped creating money to buy bonds last year, but used the proceeds to purchase more bonds. The central bank will no longer be an active buyer in the debt market.

The outlook

The Bank of Canada said the gross domestic product will increase 4.2 per cent this year and 3.2 per cent in the next five years. The rates of growth are based on Canada's pre-pandemic trajectory.

Policy-makers think the consumer price index will go up by 5.1 per cent in 2022, 4.2 per cent next year and 2.3 per cent in 2020.

The context

The January forecasts were blown up by the war in Ukraine. Western sanctions have disrupted supply chains, putting additional upward pressure on costs, while the conflict caused new spikes in prices for oil, natural gas, and other commodities.

Global inflation was thought to be a supply story a year ago. That is no longer the case. The Bank of Canada said that domestic demand in the United States is very strong.

The benchmark interest rate was 1.75 percent when the economy was strong. The Bank of Canada needs to catch up.

With the economy moving into excess demand and inflation well above target, the Governing Council judges that interest rates will need to rise further.

The takeaway

The Bank of Canada made a conscious decision to risk stoking inflation hotter than its target in order to bring about a faster recovery in the early stages of the pandemic.

Policy-makers might have done things differently if they had anticipated the fragility of supply chains, the effects of the war in Europe, and the effects of the droughts in major farming regions. The labour markets survived the recession better than anyone anticipated.

The result is more demand than supply. The central bank has a two per cent inflation target. There is a chance of another half-point increase on June 1.

Email: kcarmichael@postmedia.com