Canadians may see a 0.5% interest rate hike this week thanks to ‘persistent’ inflation

The Bank of Canada is likely to hike its benchmark interest rate another half a percentage point on June 1, further raising the cost of borrowing to tackle “persistent” inflation levels not seen in 30 years, economists predict.

Economists who spoke to Global News all said they expect the central bank’s key interest rate to rise to 1.5 per cent on Wednesday.

Money markets are also pricing in a hike of 50 basis points, economists confirmed.

Such a move would make the second consecutive jump of 50 basis points from the central bank. The last time it raised rates half a percentage point in back-to-back decisions was nearly 25 years ago, in December 1997 and January 1998.

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Benjamin Reitzes, Canadian rates and macro strategist at BMO Capital Markets, told Global News that the hike is expected due to inflation figures remaining high through the first half of 2022.

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The 6.8 per cent inflation rate recorded last month was well above the Bank of Canada’s inflation forecast released at the start of April, which pegged year-over-year price growth around six per cent in the second quarter of the year.

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Gas prices are among the areas expected to keep climbing in May, he noted, giving the Bank of Canada plenty of cause for concern in efforts to tamp down on the surging cost of living.

“Inflation is still the main story here. The Bank of Canada wants to push back on inflation and they do that by raising rates,” he said.

Inflation is beating initial expectations in part because of the prolonged war in Ukraine, according to TD Bank senior economist James Orlando.

Early in the conflict, economists had expected a “temporary spike” in prices due to gas and food supply chain constraints, but impacts three months into the war are “broader” and “much more persistent than previously thought,” Orlando explained. COVID-19 lockdowns in China contributing to global supply chain issues are among other factors.

Other central banks are also in a rate hike cycle, with the U.S. Federal Reserve also taking a half-percentage-point step in early May.

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Is a 75 bps hike in the cards?

Though the consensus for Wednesday’s decision is gathering around the 50-basis-point mark, economists who spoke to Global News said a more aggressive increase of 75 basis points is not out of the question.

Tu Nguyen, economist with RSM Canada, said that while back in January the idea of such a jump would have been inconceivable, today it’s “certainly possible.”

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Nguyen thinks the 75-basis-point move is unlikely, however, to avoid the risk of a more steep economic decline.

“I think the bank would stick with the 50-basis-point hike. They don’t want to scare the economy too much,” she said.

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Reitzes agreed, saying a 75-basis-point increase would be a “more extreme move” that wouldn’t be in line with the central bank’s messaging on interest rates to date.

While the Bank of Canada is keen to take steam out of the country’s roaring economy, two rate hikes at the start of the year have already had a cooling effect on sectors such as the housing market, where home sales are slowing and prices are showing declines in some cities.

Orlando said the real estate market has “done a 180” from just a few months back when buyers were rushing to get in before prices rose, to today when Canadians are sitting on the sidelines seeing how low prices could go.

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Sticker Shock: Canada’s housing inflation keeping prospective buyers on the sidelines

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When will rate hikes stop?

The current benchmark rate of one per cent is still stimulating the economy, Orlando noted, and the central bank itself said earlier this year that rates need to rise to the two-to-three per cent range before the bank’s monetary policy would truly be taking its foot off the gas.

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He predicts another 50-basis-point increase in July to bring the bank’s rate to two per cent, with another hike likely in September.

Reitzes predicted the same and said the bank will likely take stock of the impact of rising rates on inflation and the economy in the fall.

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Nguyen also expects the Bank of Canada will continue to raise rates through September as the bank has some “wiggle room” to increase its rate without seriously risking a recession in Canada’s “overheated economy.”

The Bank of Canada will use that runway to raise rates as it looks to maintain its “credibility” as an inflation-fighting central bank, Orlando said.

If it does not use its primary policy tool to push back on inflation, expectations of perpetual price growth could seep into the minds of consumers and businesses. If sentiment shifts and inflation is expected long term, workers will push for higher wages and businesses will plan to pass those elevated costs on to consumers, forming an endless cycle of inflation.

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“If people believe that the Bank of Canada is going to be successful in reining in inflation in the future … it enables the Bank of Canada to be more effective at doing that job,” Orlando said.

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The latest consumer and business outlook surveys from the Bank of Canada in early April showed that while inflation expectations remain high in the short term, Canadians remain confident pressures will ease in the longer term.

“The good news is that belief is still out there that this is going to be something that will eventually be reined in,” Orlando said.

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