Economists are reassessing their outlook for Canadian interest rates after the Bank of Canada’s oversized move on Wednesday and tough talk from the bank’s governor about bringing inflation back under control.
The central bank announced a rate increase of 50 basis points instead of the usual 25, bringing its policy rate up to 1 per cent. Borrowing costs are still well below prepandemic levels, and the bank said interest rates need to keep rising.
A growing number of Bay Street forecasters now expect the bank to follow up on its aggressive move this week with another 50-basis-point hike at its next meeting in June. Until recently, they had predicted the bank would move more cautiously.
Most also revised their expectations for how high rates will go over the next two years after the central bank raised its estimate of the so-called “neutral rate” (a level that neither stimulates nor holds back the economy) by a quarter percentage point on Wednesday.
As a rule, the Bank of Canada does not spell out its expected path for interest rates. But Governor Tiff Macklem said on Wednesday that he wants to get back to a neutral policy rate of between 2 per cent and 3 per cent relatively quickly. The bank previously estimated that the neutral rate lay between 1.75 per cent and 2.75 per cent.
“If demand responds quickly to higher rates and inflationary pressures moderate, it may be appropriate to pause our tightening once we get closer to the neutral rate and take stock,” Mr. Macklem said at a news conference after the rate announcement.
“On the other hand, we may need to take rates modestly above neutral for a period to bring demand and supply back into balance and inflation back to target,” he said.
Analysts took these comments to mean the bank intends to get its policy rate back up above the prepandemic level of 1.75 per cent more quickly than they had expected. The higher estimate for the neutral rate also suggests the bank could move the policy rate as high as 3 per cent, which is more than most were expecting a week ago.
“It looks as though policy rates are going to rise to neutral in a hurry and then the pace of tightening will likely slow,” Benjamin Reitzes, the Bank of Montreal’s managing director of Canadian rates, wrote in a note to clients. “Accordingly, we now look for a 50 bp [basis-point] hike in each of the next two meetings, before the BoC shifts to a quarterly pace of 25 bp hikes.”
Analysts also took note of Mr. Macklem’s pledge to act “as forcefully as needed” to get inflation back to target.
“As a result, we now expect the Bank of Canada to act ‘forcefully’ again by raising rates 50bps in June,” Royce Mendes, Desjardins head of macro strategy, wrote in a note to clients.
“It’s not a slam dunk, since the central bank penciled in some lofty inflation forecasts for Q2 that might not pan out, but 50bps has become our base case for the June announcement,” he said.
While the Bank of Canada appears keen to accelerate its campaign against inflation, elevated levels of household debt and an overreliance on real estate to drive the economy could limit how far and how fast the bank can move without causing a recession.
“We’re still skeptical that the bank will be able to get rates back to neutral, let alone the 3 per cent or higher currently priced in by the futures market,” Paul Ashworth, chief North America economist with Capital Economics, wrote in a note to clients.
“Canada’s economy is also much more dependent on residential investment than any other advanced country,” he said.
“The conundrum the Bank of Canada faces is that residential investment is the most rate-sensitive part of any economy. Even if house prices don’t fall back, squeezing household wealth and weighing on consumer spending, we can expect some marked declines in residential investment, particularly from such a high starting point.”
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.