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The Bank of Canada said it remains 'resolute' in its commitment to tackling high inflation, which is eroding wages and making life less affordable for Canadians.Sean Kilpatrick/The Canadian Press

The Bank of Canada increased interest rates for the seventh consecutive time on Wednesday, surprising markets with another oversized move while signaling that it may be nearing the end of its historic rate-hike cycle.

The bank’s governing council raised the benchmark lending rate by half a percentage point to 4.25 per cent, the highest level since early 2008.

This is the latest step in a nine-month dash to increase Canadian borrowing costs, which has driven mortgage expenses sharply higher and plunged the housing market into a deep funk. The central bank is squeezing Canadian finances in an effort to slow spending throughout the economy and get the highest inflation in four decades under control.

Investors were expecting a more dovish quarter-point increase. But even as the bank defied those expectations it softened its language about future rate increases – a sign that its rate-hike campaign is fast approaching a turning point, with a potential pause coming as early as January.

“Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance,” the bank said in its one-page rate decision statement. In previous rate announcements, the bank had said that it expected rates “will need to rise further.”

The bank said it remains “resolute” in its commitment to tackling high inflation, which is eroding wages and making life less affordable for Canadians.

Bank of Canada rate decision: Follow live updates

But after pushing the policy rate up by 400 basis points since March, in one of the fastest monetary policy tightening cycles on record, Bank of Canada Governor Tiff Macklem and his team are having to balance the risk of doing too little to fight inflation against the risk of doing too much and crashing the economy. (A basis point is 1/100th of a percentage point.)

Interest-rate increases take time to affect the economy, often up to six to eight quarters. Sectors that rely on borrowed money, such as real estate and car sales, typically get hit first. Other industries are pinched over time, as people spend more money servicing their debt and have less to spend on other things.

This lag means the Bank of Canada can’t immediately measure the effects of its rate hikes, which creates the risk that it will increase borrowing costs more than is necessary to bring inflation under control. The central bank is already forecasting near-zero growth over the next three quarters, putting the Canadian economy right on the edge of recession.

“The tightening cycle likely has reached its zenith, but we’ll need the pain of these higher rates to persist for a while to stall economic growth and thereby cool inflation,” Canadian Imperial Bank of Commerce chief economist Avery Shenfeld wrote in a note to clients.

Financial markets expect the Bank of Canada to stand pat at 4.25 per cent at its next rate decision on Jan. 25.

Inflation has trended down since the summer. Annual Consumer Price Index inflation stood at 6.9 per cent in October, down from a peak of 8.1 per cent in June, and the bank noted that three-month indicators suggest that price pressures “may be losing momentum.” That said, inflation is still more than three times the central bank’s 2-per-cent target. It does not expect inflation to reach 2 per cent until 2024.

Heading into Wednesday’s rate decision, Bay Street analysts were split over whether the bank would move by 25 or 50 basis points. Recent economic data has been ambiguous, sending conflicting signals about how much the economy is weakening in the face of higher interest rates.

Canadian GDP grew nearly twice as fast as the Bank of Canada was expecting in the third quarter, and the unemployment rate remains near a historic low. The bank said in its rate statement that the economy continues to operate with “excess demand.” That means Canadians want to buy more than the economy can supply and businesses want to hire more workers than are available, pushing up both prices and wages.

At the same time, there is growing evidence that higher interest rates are “restraining domestic demand,” the bank said. This is clearest in the housing market. National home sales were down 36 per cent year-over-year in October, and prices down 10 per cent.

There are also signs that consumers are tightening their belts. Household spending fell 0.3 per cent in the third quarter, the first drop since the second quarter of 2021.

The bank said there is more pain on the horizon, as “growth will essentially stall through the end of this year and the first half of next year.”

Mr. Macklem said in a speech last month that unemployment needs to rise to get inflation under control, although he is not expecting joblessness to increase as sharply as it did in previous recessions.

‘The tightening cycle likely has reached its zenith’: How the Street is reacting to today’s BOC rate hike

In a separate speech last month, the bank’s senior deputy governor, Carolyn Rogers, said homeowners with variable rate mortgages who stretched themselves financially to buy homes during the pandemic are experiencing a particularly “painful” adjustment. Bank of Canada research shows around half of all variable rate mortgages with fixed monthly payments have already hit “trigger rates,” which frequently means the borrowers need to up their monthly payments. This could rise to 65 per cent in the coming months, the bank projects.

Variable rate mortgages are typically tied to commercial bank prime rates. Canada’s large banks all raised their prime rates to 6.45 per cent from 5.95 per cent on Wednesday after the Bank of Canada announcement.

While Wednesday’s rate hike will squeeze some homeowners, the bank’s signal that it will stop raising rates soon is good news for the housing market, Royal LePage chief executive Phil Soper said in an interview.

He said plenty of buyers are sitting on the sidelines, not because they can’t afford homes, but because they’re uncertain about the direction of the market. “It’s not a capacity issue. It’s a confidence issue,” he said.

He thinks home prices have slightly farther to fall, and that they will bottom out in the first quarter of 2023 at about 12 per cent below the same quarter last year.

The rate decision drew the ire of opposition politicians during Question Period in Ottawa on Wednesday. Conservative Party Leader Pierre Poilievre called it “another uppercut for Canadians,” and argued that federal spending is fuelling inflation and forcing the bank to tighten rates.

NDP Leader Jagmeet Singh said the rate hike will “mean a lot of pain for Canadian families,” and called on the government to come up with “a way to tackle the inflation that doesn’t create pain for workers.”

Liberal associate finance minister Randy Boissonnault responded that the Bank of Canada is independent from politics. “The bank is doing their job, we’re doing our job,” he said.

Inflation has become a topic of intense political debate over the past year, and politicians on both the left and the right have been critical of the central bank. Mr. Poilievre has said he would fire Mr. Macklem if the Conservatives form government, while Mr. Singh has said the bank’s approach to inflation fighting has “absolutely no merit.”

Josh Nye, senior economist with Royal Bank of Canada, said it’s too early to judge whether or not the bank’s aggressive rate-hike campaign has been a success.

“Whether they have calibrated monetary policy properly to the situation, that’s only going to be apparent in hindsight. I think that will depend on how much economic activity slows in 2023 and how quickly inflation gets back down to the bank’s 2-per-cent target,” he said.

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