The Bank of Canada announced its fourth interest rate hike of the year at Wednesday’s July policy meeting. The central bank raised its benchmark interest rate by one percentage point, the third consecutive oversized rate hike of the year and an aggressive step forward in its campaign to tackle runaway inflation.
How many more rate hikes are expected this year? What will they mean for inflation? Here’s everything we know about the latest Bank of Canada interest rate increase.
What rate hike did the Bank of Canada announce at its July policy meeting?
The Bank of Canada announced another oversized interest rate hike on Wednesday. The central bank’s governing council voted to raise the policy rate by one percentage point – the most aggressive rate hike since 1998 and a larger move than investors and private-sector economists were expecting. That brings the benchmark rate to 2.5 per cent, pushing the bank’s policy rate well above the prepandemic level.
This is the fourth consecutive interest rate increase since March, and puts the Bank of Canada ahead of its peers when it comes to tightening monetary policy in the face of the most significant inflation shock in a generation. The bank also signaled that interest rates will need to keep rising to cool down Canada’s overheated economy and slow the pace of consumer price growth.
“With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the governing council decided to front-load the path to higher interest rates,” the bank said in its rate decision statement.
Ahead of Wednesday’s announcement, investors and private-sector economists were widely expecting a 0.75 percentage point increase. The Bank of Canada’s governing council, however, opted for a super-sized move in response to broadening inflation pressures and worrying signs that inflation expectations are becoming unanchored.
When was the last interest rate hike? Will there be more?
The central bank is in the middle of its fastest rate hike cycle in decades. After keeping its benchmark interest rate near zero for the first two years of the COVID-19 pandemic, the Bank of Canada’s governing council started pushing interest rates higher, at the fastest pace in decades, since March 2022.
At the April and June policy meetings, the bank announced two consecutive oversized interest rate hikes and said that it is prepared to “act more forcefully if needed.” Before the April rate hike, the central bank had not announced a half-point increase for two decades. It typically moves in quarter-point increments.
Central bank officials say they want to get the policy rate to a “neutral” level, which neither stimulates nor holds back the economy, relatively quickly. It estimates this rate is somewhere between 2 per cent and 3 per cent.
Wednesday’s move puts the policy rate back in the so-called neutral range, where it neither stimulates nor restricts the economy. Bank of Canada Governor Tiff Macklem said that the rate will need to keep rising, likely to 3 per cent or slightly above. He said future interest rate decisions will be driven by incoming economic data.
How high rates ultimately go will depend on how the Canadian economy reacts to higher borrowing costs. After getting to a “neutral” level, further rate decisions will depend on variables such as housing market strength, consumer spending and the direction of inflation itself.
When are the remaining Bank of Canada interest rate announcements in 2022?
Markets are pricing in rate hikes at each of the bank’s three remaining decision dates in 2022, which would bring the policy rate to around 3 per cent by the end of the year:
- Wednesday, September 7
- Wednesday, October 26
- Wednesday, December 7
Could rising interest rates cause a recession?
As monetary policy tightens quickly, global investors are betting that a recession will follow, which has led to a selloff in stock markets and lower prices for commodities, such as crude oil.
Last week, Royal Bank of Canada became the first large Canadian bank to forecast a recession, starting in 2023. RBC economists Nathan Janzen and Claire Fan tempered their prediction by saying it would be a “moderate and short-lived” recession.
Meanwhile, economic data has been underwhelming heading into this week’s rate decision. Canada’s economy appears to have slowed unexpectedly in May, according to preliminary estimates from Statistics Canada. Likewise, the country lost 43,000 jobs last month, Statscan reported on Friday.
Bank of Canada, however, is not forecasting a recession in Canada in the next two years as its base case. But its quarterly Monetary Policy Report, published Wednesday, does warn that the risk of a recession would rise if high inflation becomes baked into consumer and business psychology, triggering a wage-price spiral.
What does the supersized rate hike mean for inflation?
The Bank of Canada is moving rates rapidly higher to deal with the highest inflation in decades.
Inflation has trended higher for more than a year, hitting an annual rate of 7.7 per cent in May, the highest since 1983. Rising energy, food and shelter prices, in particular, are aggravating affordability challenges for many Canadians and becoming a major political issue.
In fact, inflation is becoming impossible to avoid, with more than half of the components of the consumer price index rising at an annual rate of more than 5 per cent in May. That’s aggravating cost-of-living concerns for many Canadians. Also, higher rates make it more expensive for businesses and households to borrow money.
There are some signs, however, that inflation is approaching a peak. Commodity prices have dropped in recent weeks and transportation costs have fallen from record highs. But it is a long way back to the Bank of Canada’s inflation target of 2 per cent, and central bank officials are increasingly concerned that high inflation will become baked into people’s psychology.
In practical terms, higher interest rates curb demand by making it more expensive to borrow money. This shows up in higher interest rates for things such as mortgages, home equity lines of credit, business loans, credit cards, student debt and car loans.
According to the July policy meeting, the bank now expects the rate of inflation to average 7.2 per cent in 2022 and 4.6 per cent in 2023 – considerably higher than it forecast in April. It does not expect inflation to return to its 2 per cent target until 2024.
How will the expected Bank of Canada rate hike affect house prices and mortgages?
Housing is the most interest-rate sensitive part of the economy, and there are already signs that the housing market is slowing as mortgage rates have moved higher.
Canadian home prices and sales dropped in May for a second straight month. The national home price index fell 0.8 per cent to $822,900 on a seasonally adjusted basis, according to the Canadian Real Estate Association. In the Toronto region, the largest real estate market in the country, home resales dropped 41 per cent in June compared to last year. The typical Toronto home price is down nearly 10 per cent from the March peak to June.
Some economists are predicting that Canadian home prices will fall as much as 20 per cent this year.
For individual homeowners, the impact of higher rates depends on what type of mortgage you have. People with fixed-rate mortgages, the majority of Canadian homeowners, will pay the new rates when they renew their mortgage contracts. These types of mortgages follow the bond market, and interest rates on bonds have moved sharply higher this year in anticipation of Bank of Canada rate increases.
For people with variable-rate mortgages, it will depend on the structure of the mortgage. Some people will see monthly payments rise immediately. Other variable rate mortgages, however, have fixed payments; that means monthly payments won’t necessarily increase, but less will go each month to paying off the mortgage principal.
If you have a variable mortgage rate with fixed payments, you can estimate your own trigger rate with the calculator below.
Which other countries are also hiking interest rates?
The Bank of Canada is not alone in signalling a more aggressive path for higher rates. Other central banks, most notably the U.S. Federal Reserve, have pivoted in recent months to forecasting a rapid rise in borrowing costs.
On June 15, the Fed announced its largest interest rate hike since 1994 and said that it would continue pushing borrowing costs higher in an effort to restrain the highest inflation in four decades. The Federal Open Market Committee, which manages U.S. monetary policy, announced a 0.75 percentage point interest rate increase, lifting the benchmark federal funds rate to between 1.5 per cent and 1.75 per cent.
Fed Chair Jerome Powell said he did not expect moves of 75 basis points to become common, but the Fed would likely consider a hike of 50 or 75 basis points at its meeting in July. The United States is grappling with the highest inflation in years, hitting a new 40-year high in June. Consumer prices soared 9.1 per cent compared with a year earlier.
Meanwhile, the Bank of England raised interest rates on June 16 to their highest level in 13 years in a bid to tackle soaring inflation. The bank’s Monetary Policy Committee voted to increase the interest rate by 0.25 percentage points to 1.25 per cent. Inflation in the United Kingdom accelerated to a 40-year high of 9 per cent in May, the highest level since 1982.
Compiled by Abigale Subdhan.
With reports from Mark Rendell, Rachelle Younglai and Reuters.
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