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After holding borrowing costs at record lows for the first two years of the COVID-19 pandemic, the Bank of Canada pivoted abruptly this spring.Adrian Wyld/The Canadian Press

The Bank of Canada announced another oversized interest rate hike on Wednesday and said that it is prepared to “act more forcefully if needed,” signalling that it intends to keep pushing borrowing costs rapidly higher in an effort to bring inflation back under control.

The central bank’s governing council voted to raise the policy rate by half a percentage point – its third interest-rate increase this year. That brings the benchmark rate to 1.5 per cent, just a quarter point below the prepandemic level.

Bank of Canada has raised its benchmark interest rate to 1.5%. Here’s what that means for Canadians

The move was widely expected by analysts and investors. But the tone of the statement was striking. The central bank warned that the rate of inflation will likely move higher in the coming months, led by a jump in food and energy prices, and cautioned that “the risk of elevated inflation becoming entrenched has risen.”

“With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the governing council continues to judge that interest rates will need to rise further,” the bank said in its rate announcement statement.

Wednesday’s move follows rate increases in March and April, the latter of which was also a half-point increase rather than the usual quarter-point move. This is the first time that the bank has announced back-to-back 50-basis-point rate increases since beginning fixed-date interest-rate announcements in 2000. (A basis point is a hundredth of a percentage point.)

After holding borrowing costs at record lows for the first two years of the COVID-19 pandemic, the Bank of Canada pivoted abruptly this spring. It is now moving aggressively to make up for the fact that it didn’t hike interest rates earlier and to shore up its credibility as an inflation fighter.

Inflation has been above the bank’s target range of 1 per cent to 3 per cent for more than a year, hitting a three-decade high of 6.8 per cent in April.

Higher interest rates are already reverberating through the economy, most notably in the rate-sensitive housing market. The number of home sales across the country fell 12.6 per cent from March to April on a seasonally adjusted basis, while the home price index slid 0.6 per cent, according to the Canadian Real Estate Association.

The central bank faces a “delicate balance” as it tries to cool Canada’s overheating economy without triggering a recession, Governor Tiff Macklem said after the last rate decision in April. At the same time, the near-term economic growth outlook remains positive thanks to strong consumer spending and exports, the bank said Wednesday.

The bank’s comment that it is willing to “act more forcefully” opens the door to 75-basis-point rate increases in the future, said Benjamin Reitzes, Bank of Montreal’s director of Canadian rates, in a note to clients. Mr. Macklem had previously said that he would not rule anything out, but that a 75-basis-point rate hike would be “very unusual.”

“Don’t expect the hawkish rhetoric to let up until inflation starts to trend lower,” said Mr. Reitzes. “We continue to look for another 50-bp hike in July, but there’s a risk of a 75-bp move if inflation surprises to the high side yet again.”

Inflationary pressures are broadening out to a wider range of goods and services, making it harder for Canadians to avoid. Nearly 70 per cent of the components of the consumer price index are experiencing inflation above 3 per cent, the central bank noted in its statement.

Higher interest rates won’t do much to deal with international sources of inflation, which include persistent supply chain bottlenecks, COVID-19 lockdowns in China and surging commodity prices after Russia’s invasion of Ukraine.

But higher rates will dampen demand in the Canadian economy. That can impact domestic sources of inflation tied to the service sector, housing market and tight labour market. In practice, this happens by increasing the cost of borrowing money, which shows up in things such as interest rates on mortgages, business loans and car loans.

Interest-rate changes can take six to eight quarters to have a full impact on the economy. But they show up in certain sectors sooner than others: notably in housing markets and real estate investment.

Phil Soper, president and chief executive of the real estate company Royal LePage, said that Canada’s housing market started cooling off last fall, as it became clear that home prices were way overstretched. The rate hikes from the Bank of Canada this spring are “acting as a further tap on the brake for a market that was already slowing,” he said.

Each 50-basis-point hike from the central bank adds around $2,000 a year to the average mortgage, Mr. Soper said. Whether homeowners will pay this right away depends on what type of mortgage they have.

He said that there could easily be a 10-per-cent correction in Canadian home prices this year, although this may vary from region to region.

Despite the string of rate hikes since March, the Bank of Canada’s policy rate remains low by historic standards and continues to stimulate the economy. Central bank officials have said they intend to get the benchmark rate to a “neutral” level relatively quickly. They estimate that this is somewhere between 2 and 3 per cent.

Ahead of Wednesday’s announcement, markets were pricing in another half-point move in July, then smaller quarter-point moves at each of the bank’s remaining meetings this year. That would bring the policy rate to around 3 per cent by the end of the year.

Some Bay Street economists have argued that this potential path for interest-rate increases is too aggressive, given how much of the Canadian economy is based on real estate and how sensitive Canada’s highly indebted households are to higher borrowing costs.

“Recent economic data has been quite strong on balance, and it’s both easy and appropriate to sound hawkish when both growth and inflation are running hot,” Andrew Kelvin, Toronto Dominion Bank’s chief Canada strategist wrote in a note to clients.

“As we move into the fall, we expect data will begin to show signs of a broader slowdown as higher interest rates begin to bite into growth. The bank may be able to maintain its hawkish tone into the July meeting, but when growth begins to slow, the change in tone could be abrupt.”

Bank officials have said they aren’t on “autopilot.” Whether they stop raising rates once the policy rate reaches the 2-per-cent to 3-per-cent range will depend on how the economy reacts to higher borrowing costs.

Deputy Governor Paul Beaudry will give a speech on Thursday explaining the bank’s rationale for this week’s rate decision.

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