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The Bank of Canada’s revised economic forecast for Canada paints a gloomy picture of the year ahead.Sean Kilpatrick/The Canadian Press

The Bank of Canada increased borrowing costs again for Canadians on Wednesday, but hinted that its aggressive campaign of interest rate hikes is nearing an end, as the economy teeters on the edge of recession.

The central bank raised its benchmark rate by 0.5 percentage points, its sixth consecutive hike since March. The move was smaller than financial markets were expecting, but still brings the policy rate to 3.75 per cent, its highest level since early 2008.

Bank Governor Tiff Macklem told a news conference that further rate hikes are needed to get inflation, currently running near a four-decade high, under control. At the same time, he said, the bank needs to be more cautious about risks to the economy from higher interest rates, with growth expected to “stall” in the coming quarters.

“We are trying to balance the risks of undertightening and overtightening,” Mr. Macklem said. “If we don’t do enough, Canadians will continue to endure the hardship of high inflation. … If we do too much, we could slow the economy more than needed.”

This marks a notable shift in tone and strategy. The bank has raised borrowing costs at a breakneck pace since March, arguing that the first inflation shock in a generation has to be met with an overwhelming response. Higher rates make it more expensive for households and businesses to borrow money. The bank’s goal is to curb demand for goods and services and slow down the speed of price increases.

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Eight months into the bank’s monetary policy tightening campaign, Mr. Macklem and his team are in a tricky spot. The Canadian housing market has entered a lengthy slump, and consumers and businesses are cutting back on spending in response to high prices and rising debt-service costs. At the same time, inflation remains stubbornly high.

This means central bank officials need to keep talking tough on inflation while preparing financial markets and the broader public for a pause in rate hikes. “This tightening phase will come to a close. We’re getting closer to that point, but we’re not there yet,” Mr. Macklem said.

Wednesday’s decision caught financial markets by surprise. Mr. Macklem had been hawkish in his communications ahead of the announcement, leading bond traders and private-sector economists to expect a larger 0.75-percentage-point rate increase.

Many also thought the bank would move aggressively to keep pace with the U.S. Federal Reserve, as a way of preventing further deterioration of the Canadian dollar, which has fallen nearly 10 per cent against the U.S. dollar in the past year. Markets expect the Fed to announce another 0.75-percentage-point rate increase in early November.

Canadian bonds rallied sharply, with the yield on the two-year Government of Canada bond falling 26 basis points on Wednesday. (A basis point is one one-100th of a percentage point.) Bond prices and yields move in opposite directions. Canadian stocks also jumped, with the TSX Composite Index rising 0.96 per cent, compared with a 0.74-per-cent drop in the U.S. S&P 500 index.

Benjamin Reitzes, Bank of Montreal’s director of Canadian rates, said in a note to clients that the central bank is trying to achieve a fine balance, “threading the needle of taming inflation while not putting too much pressure on the economy.”

“Today’s decision puts a bit more emphasis on the economy. Hopefully that doesn’t come back to haunt them in 2023 if inflation remains stickier than expected,” he wrote.

The Bank of Canada’s revised economic forecast for Canada paints a gloomy picture of the year ahead. It now expects near-zero growth in the coming quarters and only 0.9-per-cent annual GDP growth for all of next year, down from its previous estimate of 1.8 per cent.

Meanwhile, the bank expects the global economy to grow only 1.6 per cent next year as countries around the world deal with higher interest rates, energy shortages, and continuing disruptions related to COVID-19 and the war in Ukraine. That would be the slowest global growth since 1982, excluding the 2008 financial crisis and the first year of the pandemic, the bank noted in its quarterly monetary policy report.

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Mr. Macklem avoided using the word “recession” when talking about the bank’s forecast for Canada. But he said that several quarters of negative growth – a common definition of recession – are now as likely as not. “That’s not a severe contraction. But it is a significant slowing of the economy,” he said.

“As it’s rare for central banks to forecast recessions until they start, a sceptic might take this as a sign that the Governing Council in fact now judges that a moderate recession is more likely than not,” Stephen Brown, senior Canada economist with Capital Economics, wrote in a note to clients.

The bank is intentionally crimping economic growth. Although bank officials have revised down their growth forecasts, they still believe there is what they call “substantial excess demand” in the Canadian economy. That means people want to buy more goods and services than the economy can supply, and businesses want to hire more workers than are available. This is showing up in higher service prices and rising wages.

“There are no easy outs to restoring price stability. We need the economy to slow down to rebalance demand and supply and relieve price pressures,” Mr. Macklem said.

Bank of Canada Governor Tiff Macklem told a news conference on Oct. 26 that further rate hikes are needed to get inflation, currently running near a four-decade high, under control.Sean Kilpatrick/The Canadian Press

Consumer price index inflation has fallen in recent months, hitting an annual rate of 6.9 per cent in September, down from a high of 8.1 per cent in June. Still, much of the decline so far has come from lower gasoline prices. Other prices continue to push higher, with nearly two-thirds of the components of the consumer price index seeing annual price increases above 5 per cent. The bank’s target is 2-per-cent annual CPI growth.

Canadians are being hit particularly hard at the grocery store, where food prices rose 11.4 per cent year-over-year in September – the biggest jump since 1981.

There are some signs that inflation is heading in the right direction. The bank’s most recent business survey showed that companies are expecting to slow down price increases next year. And quarterly “core inflation” data, which strips out more volatile elements of the consumer price index, are showing some signs of easing.

Still, there are plenty of things that could cause inflation to increase. A spike in oil prices or more supply chain disruptions tied to the war in Ukraine could push up prices. Also, service-sector inflation in Canada could prove “stickier,” Mr. Macklem said.

The bank cut its inflation forecast slightly. It now expects consumer price index inflation to average 6.9 per cent in 2022, down from the previous projection of 7.2 per cent. It sees inflation averaging 4.1 per cent in 2023, down from an earlier forecast of 4.6 per cent, and hitting 2.8 per cent by the fourth quarter of next year.

The bank has been heavily criticized by federal Opposition politicians in recent months: first by the Conservatives for allowing inflation to surge, and more recently by the NDP for pushing interest rates rapidly higher. Conservative Party Leader Pierre Poilievre has promised to fire Mr. Macklem if the Conservatives form government. NDP Leader Jagmeet Singh said this week that “there’s absolutely no merit” to the bank’s approach to fighting inflation.

Mr. Macklem responded to the criticism on Wednesday by saying that the bank’s inflation-control mandate is clear, and the bank is following it. “The independence of the central bank becomes more important when the decisions are difficult,” he said.

The bank’s next rate decision is on Dec. 7. Mr. Macklem said Canadians should expect another rate hike that month, although he offered few hints about how big it would be. Analysts expect the bank to announce one or two more rate hikes before pausing.