Canada’s central bank is expected to raise interest rates again at its next policy meeting this week in response to the highest inflation in decades.
After keeping borrowing costs near zero for the past two years in an effort to stimulate economic activity amid the Covid-19 pandemic, the Bank of Canada is now trying to quickly control the surge in consumer prices and to withdraw monetary support. So far, policymakers led by Governor Tiff Macklem have raised borrowing costs at the last two consecutive policy meetings, with another hike expected on Wednesday. This time, however, markets and economists are expecting a second rate hike of 50 basis points, an unusually aggressive move that would push borrowing costs to 1.5%.
By historical standards, such a hawkish succession of monetary policy tightening certainly seems extraordinary – in fact, the last time the Bank of Canada announced a half-percentage-point increase was more than 20 years, opting instead for increases of 25 basis points. But Macklem is finally starting to feel the heat from rapidly accelerating inflation, which hit 6.8% last month, well above the central bank’s target rate of 2%.
“We are facing an economy that is showing clear signs of overheating, very tight labor markets and this perfect inflationary storm of world events and changing preferences. [in consumer spending]Bank of Canada Deputy Governor Toni Gravelle said in a speech earlier this month. “Put simply, with demand outstripping the capacity of the economy, we need higher interest rates to curb domestic inflation.”
Yet raising interest rates in an attempt to curb inflation comes with its own set of downsides, namely the subsequent negative effect on the Canadian housing market. The latest data from the Canadian Real Estate Association showed home sales fell 12.6% month-over-month in April, while prices fell 0.6% as as markets cool in response to rising mortgage costs.
During his speech, Gravelle warned that rising interest rates could have a much more severe impact on household finances compared to previous tightening cycles, as debt service costs are going to be much higher. , subsequently reducing consumer spending more aggressively than it otherwise would. But, if the central bank spends “too much time focusing on the headwinds facing the economy (slowing housing activity, eroding consumer confidence), markets may come to believe that the bank is unwilling to control inflation, which would lead to an unanchoring of inflation expectations. and requiring a more painful tightening cycle,” warned TD chief strategist Andrew Kelvin.
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