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Bank of Canada Governor Tiff Macklem attends a news conference in Ottawa on Dec. 15, 2021. On Wednesday, policy makers decided to keep the central bank’s key interest rate at its record-low 0.25 per cent, where it has been since the early days of the pandemic.Justin Tang/The Canadian Press

If the degree to which the Bank of Canada has rolled up its sleeves is indicative of how intensely it’s about to get to work on quelling the inflation problem, then brace yourselves. Those sleeves are balled right up to the shoulder after Wednesday’s interest rate decision.

Don’t misread the bank’s decision to not actually start that process for a few more weeks. Everything else about Wednesday’s announcement, and accompanying quarterly Monetary Policy Report (MPR), screamed the case to raise rates. Probably more quickly than many pundits were thinking.

“The Bank [of Canada] did a very good job at producing a ‘hawkish hold’ today,” CIBC Capital Markets strategist Ian Pollick said in an e-mail on Wednesday.

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Indeed, we may have never seen a rate hold this hawkish before.

First, the obvious: The bank came right out and said that it plans to raise rates very soon – and that Wednesday’s announcement was, basically, clearing the tracks in preparation. This isn’t something central banks typically do. In this case, Bank of Canada Governor Tiff Macklem underlined the point in his post-announcement news conference. He wanted to make sure no one missed it. The bluntness had a certain “don’t say we didn’t warn you” feel to it.

Looking at the economic projections the bank laid out in the MPR, we can see why.

The inflation outlook for 2022 is now nearly a full percentage point higher than the bank’s forecast in October – a marked shift in its thinking about the temporary nature of price increases. After saying that inflation would peak in the fourth quarter of 2021, the bank now sees the rate averaging “close to 5 per cent” – actually slightly above the fourth-quarter pace – over the entire first half of 2022.

It said the supply woes that have been pushing up prices “have been larger, broader, and more persistent than originally anticipated.” Its base-case assumption is that supply-related price surges won’t reverse themselves when the strains ease.

The message has moved very, very far from “inflation is transitory.”

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People shop for milk at a grocery store in Toronto on Dec. 8, 2021. The inflation outlook for 2022 is now nearly a full percentage point higher than the bank’s forecast in October – a marked shift in its thinking about the temporary nature of price increases.Christopher Katsarov/The Globe and Mail

But perhaps more pressing is the bank’s assessment of the economy: While supplies have been hamstrung, demand has grown much faster than anticipated. The result is an economy that is, for all practical purposes, running at full capacity – which is usually when the inflationary heat begins.

Given that the Bank of Canada expects economic growth to remain well above the typical pace of capacity growth over the next couple of years, the implication is that we’re heading into excess demand – an inflationary condition even in the absence of the price spikes that have already occurred.

The case for rate hikes is unquestionable. The argument for rapid ones is compelling.

The bank noted that for now, its surveys of consumers and businesses indicate that expectations for longer-term inflation remain “well anchored” around the bank’s target of 2-per-cent inflation. It seems at odds with the abundant anecdotal evidence that we’re more worried about inflation than we have been in a generation or more. To the extent that the surveys are accurate, that confidence is surely predicated on faith that the central bank will raise rates as necessary to wrangle inflation back toward the target.

The Bank of Canada itself suggested it’s a race against time to keep this faith intact.

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The Bank of Canada noted that for now, its surveys of consumers and businesses indicate that expectations for longer-term inflation remain 'well anchored' around the bank’s target of 2-per-cent inflation.Adrian Wyld/The Canadian Press

“Until inflation moves significantly lower, there is an elevated risk that Canadians will start to believe that inflation will stay high over the long term,” the bank said in the MPR. “Higher inflation expectations could in turn lead to more pervasive labour costs and inflationary pressures and could become embedded in ongoing inflation.”

It’s a reasonable inference, then, that the bank sees value in using rates to hammer inflation down sooner rather than later.

The bank’s inflation forecasts may also contain a clue that the initial rate hikes could come fast and furious. Despite the higher inflation expectations for 2022, the bank sees inflation in 2023 to be precisely where it projected previously: 2.3 per cent. Although it’s not saying so, earlier and faster rate hikes are surely part of the equation for getting there.

How high could we go? Well, the good news for borrowers (and not so good news for savers), is probably not very high by historical standards. Economists and the bank itself see something around 2 per cent to be a roughly neutral level for the key rate – where it is neither slowing nor stimulating the economy. We can expect the Bank of Canada to take a step back to allow its rates to do their work, and assess the economic impact, well before then; the rate cycle could easily go on pause once we’re in the 1.5 per cent range, maybe even earlier.

But if inflation is going to cool, and long-term expectations are going to be preserved, then getting there may prove a faster trip than many financial market participants have prepared for. And frankly, the quicker the ramp-up, the less likelihood that the bank will have to go even higher to put inflation to rest. Hard work over the next few months could mean less work – and less pain – down the road.

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