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The Bank of Canada may have hit pause on further interest rate hikes, but that doesn’t mean the steepest tightening cycle in decades is over. Instead, in real terms, monetary policy is set to become even more restrictive over the next year, even if the bank leaves its policy rate unchanged.

Real interest rates – a measure of the policy rate minus inflation – are critical to the investment and borrowing decisions of consumers and businesses. For instance, low or negative real rates encourage borrowing since inflation reduces the real amount that has to be repaid.

And despite last year’s hikes, real monetary policy was historically lax. That’s changed as inflation cools, to the point that real rates are back to where they were prior to the pandemic and rising fast.

“Despite the expected stability of the policy rate for most of 2023, monetary policy will continue to tighten by year-end due to the predicted decline in inflation,” René Lalonde, director of forecasting at Bank of Nova Scotia, wrote in a recent note.

To get a sense of how much more real monetary policy may tighten, Mr. Lalonde looked at the forecast inflation rate to the end of 2024, and assumed the Bank of Canada holds its policy rate at 4.5 per cent this year, before cutting it in 2024.

The result: Monetary policy will grow more restrictive through the end of 2023 by the equivalent of an additional 150 basis points in rate hikes. (A basis point is 1/100th of a percentage point.) That tightening will lead to slower GDP growth over and above the “lagged and intensifying effects from past policy rate hikes,” he wrote.