Hiking events

The Bank of Canada is expected to launch a rate hike cycle

The Bank of Canada is expected to begin a series of interest rate hikes this week to fight inflation from a three-decade high.

The 27 economists polled by Bloomberg News expect Governor Tiff Macklem to raise the benchmark interest rate by a quarter of a percentage point to 0.5% in a policy decision on Wednesday. The Bank of Canada is also unveiling part of its plan to reduce holdings of government bonds acquired over the past two years.

Tiff Macklem speaks at a press conference in Ottawa in May 2020. (Bloomberg News)

The rate move would be the first increase in borrowing costs since 2018, beginning what is expected to be one of the fastest rising cycles since the central bank adopted an inflation target three decades ago. Markets expect a total of six increases over the next 12 months. Russia’s invasion of Ukraine is unlikely to deter the Bank of Canada, with soaring commodity prices shielding Canada from any broader global economic fallout.

“A hike this week will be the first leg of the most significant tightening cycle in decades, Royce Mendes, head of macro strategy at Desjardins Securities Inc., said by email. “Central bankers need to slow scorching inflation without causing a recession.”

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Wednesday’s decision at 10 a.m. in Ottawa is a statement-only matter with no new forecasts. But Macklem will deliver a speech and hold a press conference on Thursday, where he will provide more information about the decision.

The Bank of Canada, which has kept its benchmark at the emergency level of 0.25% since March 2020, has already begun to lay the groundwork. In his last policy decision in January, Macklem warned that higher borrowing costs are imminent in an economy at full capacity and no longer in need of extraordinary stimulus.

The central bank also sought to reassure Canadians that despite a relatively optimistic outlook for inflation, officials are ready to adjust quickly should price pressures prove more persistent than expected. Inflation is currently at a three-decade high of 5.1%, but officials continue to blame problems in the global supply chain which they say will fade in the coming months.

In its latest projections, the Bank of Canada expects inflation to decline to around 3% by the end of this year and close to its 2% target in 2023.

“We will be nimble — and if necessary, forceful — in using our monetary policy tools to deal with any situation that arises,” Deputy Governor Tim Lane said in a Feb. 16 speech.

What Bloomberg Economics says…

“We expect a 25 basis point hike, in our view, but we express our willingness to pick up the pace if necessary. A clear signal of further movement in April is likely, as is language that signals that balance sheet reduction is imminent The conflict between Russia and Ukraine is unlikely to shake the Bank of Canada’s resolve to begin normalizing rates.

–Andrew Husby, Economist

There are risks to consider as lending costs rise, and the process will be a delicate balancing act. Canadian households are among the most indebted among advanced countries. Housing is the main driver of growth, a sector likely to slow as the cost of borrowing rises.

Markets are betting that the Bank of Canada’s overnight rate will hit 1% by June and 1.75% by this time next year. Banks use this benchmark to assess customers’ borrowing costs on variable rate mortgages.

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The Bank of Canada building is seen at the intersection of Bank and Wellington streets in Ottawa. (Bloomberg News)

“Once the policy rate moves above 1%, financial stability considerations will come to the fore,” Simon Harvey, head of currency analysis at Monex Europe Ltd., said via email.

The invasion of Ukraine and the resulting global market turbulence complicates the decision.

Even as it prepares to withdraw its stimulus, the central bank will be ready to quickly reorient policy and inject liquidity into financial markets should investors become even more shaken. Meanwhile, soaring commodity prices will only fuel inflationary pressures and drive up incomes and demand in Canada’s resource-based economy. It’s a messy political environment.

Macklem told lawmakers last month he would be deliberate and clear on rate hikes so that “monetary policy is a source of confidence rather than another source of uncertainty.” That in itself would have made a half-percentage-point increase this week unlikely. The events in Ukraine effectively rule out this possibility.

In an interview with The Globe and Mail in January, Macklem said one option would be to start with a few rate hikes followed by a break to “assess the situation” before starting again.

The Bank of Canada can also withdraw its stimulus by allowing its bond holdings to deplete rather than raising its policy rate, giving it some flexibility in the pace of increases. The central bank has seen its holdings of federal government bonds increase by about $350 billion ($275 billion) during the pandemic, and is expected to give guidance on Wednesday on its plans to offload those assets.

“The Bank of Canada will likely provide more guidance this week on how quantitative tightening is working,” Citigroup Global Markets Inc. economist Veronica Clark said by email. “This includes whether they end the total reinvestment amount initially or gradually increase it.”