The Bank of Canada Has Been On a Rate-Hiking Tear. Is That About to Change?

When the COVID-19 pandemic hit, the Bank of Canada unleashed a monetary firehose. The central bank’s overnight policy rate was slashed from 1.80% to 0.25% in short order. Most observers (including the Bank itself) expected rates to stay low for an extended period.

How times change. The Bank of Canada’s easy monetary policy of the pandemic era was largely predicated on inflation staying low. Indeed, both the Bank’s rate cuts and bond-buying program (quantitative easing) were designed to prevent a scenario of falling prices, a spectre central banks have been keen to avoid since the deflationary Great Depression.

But as every consumer knows, the low-inflation days of mid-2020 are long gone. Supply-chain bottlenecks, pandemic stimulus programs, and central bank largesse combined to create a surge in inflation not seen in decades.

As the following chart shows, increases in the Consumer Price Index soared well past the Bank of Canada’s 2% target—reaching 8% year-over-year in the middle of 2022. We now sit just shy of 4%.

Source: Bank of Canada

In response to this burst of inflation, the central bank has raised interest rates aggressively, from 0.25% in March 2022 to 5.00% as of October 6, 2023.

The question on everyone’s minds right now is, “Will the Bank of Canada hike again, or are they done?”

Truth be told, one more hike can’t be ruled out. On October 3, the central bank’s deputy governor, Nicolas Vincent, warned of a risk that corporate behaviour could entrench higher prices.

This development, he said, “could complicate our return to low, stable and predictable inflation.”

Analysts took Vincent’s comments as hawkish, and a potential sign that the Bank of Canada thinks it has more tightening to do. The central bank may also be swayed by the blowout September employment report, which showed three times as many jobs created as economists had expected.

Why They’re Probably Done Hiking—Or Close to It

In hiking its key policy rate, the Bank of Canada has been trying to subdue inflation by slowing the economy. Higher rates should lead to less borrowing, and less borrowing should in turn feed through to lower aggregate demand. What’s critical to understand is that monetary policy works with a lag—it typically takes anywhere from 6-18 months for the economy to fully feel the effects of rate hikes (or cuts).

2023 has been evidence that the central bank’s rate hike campaign is working. Despite the good September employment news, the fact remains that the Canadian economy has been decelerating for much of the year.

This fact was brought home by a notably weak second quarter GDP report, which showed that the economy contracted by 0.2%.

The Canadian Press observed that, “The decline in the second quarter came as housing investment fell 2.1 per cent to post its fifth consecutive quarterly decrease. New construction dropped 8.2 per cent in the quarter, while renovation spending fell 4.3 per cent.”

Inflation won’t go down in a straight line. That said, the rate of change has already been cut in half (from an 8% CPI to just under 4%). With an increasingly weak economy, this trend should continue, and CPI should in turn move towards the Bank of Canada’s 2% target.

As central banks often are, the Bank of Canada is likely to be caught off-guard by how weak the economy will get in coming quarters. Indeed, we only need a negative 3rd quarter GDP print for Canada to technically enter recession territory.

Belatedly seeing a recession staring itself it in the face, odds are that the central bank will begin to slash interest rates by early 2024 to ward off a deeper downturn. They will probably cut rates much deeper than most analysts now think possible.

For anyone considering parking money in GICs or high-interest savings accounts, today’s rates seem like a gift that may not last long. Meanwhile, variable mortgage rates should decline in coming quarters, some welcome relief for those borrowers that have seen their payments surge.

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Smarter Loans Staff

The Smarter Loans Staff is made up of writers, researchers, journalists, business leaders and industry experts who carefully research, analyze and produce Canada's highest quality content when it comes to money matters, on behalf of Smarter Loans. While we cannot possibly name every person involved in the process, we collectively credit them as Smarter Loans Writing Staff. Our work has been featured in the Toronto Star, National Post and many other publications. Today, Smarter Loans is recognized in Canada as the go-to destination for financial education, and was named the "GPS of Fintech Lending" by the Toronto Star in 2019.