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The Bank of Canada is dealing with the first inflation surge in a generation. After eight consecutive interest rate hikes, it paused monetary policy tightening in March and held the key rate steady in April. The next scheduled rate decision is on June 7, 2023.

How interest rates affect your mortgage

What’s happening with inflation in Canada?

Canada is experiencing the first period of high inflation in a generation. Over the past two years, goods and service prices have risen rapidly, eroding the purchasing power of the dollar and making life less affordable for Canadians.

Inflation is measured by the annual change in the Consumer Price Index. The Bank of Canada’s overarching goal is keeping this to 2 per cent. CPI inflation hit a four-decade high of 8.1 per cent in June, and it has been trending down since then. It clocked in at5.2 per cent in February, and the central bank expects it to fall to around 3 per cent by the middle of the year.

The drivers of inflation have changed over time. Prices took off in 2021 when high demand for goods – fuelled by government support cheques and low interest rates – ran into supply problems caused by COVID-19. Russia’s invasion of Ukraine pushed global food and energy prices sharply higher.

Oil prices have dropped since last summer and supply chains have improved, lowering shipping costs and leading to a decline in goods inflation. Today inflation is increasingly driven by rising service prices. This is tied to the tightness in Canada’s labour market and rapid wage growth.

What’s the Bank of Canada doing about inflation?

The Bank of Canada uses interest rates to control inflation. By raising rates, the bank makes it more expensive for households and businesses to borrow money and service their debts. This reduces demand for goods and services, hopefully slowing the pace of price increases.

The bank has raised its benchmark rate eight times since March, 2022 – one of the fastest monetary policy tightening cycles on record. It held its overnight rate steady at 4.5 per cent at its March 8 and April 12 rate decisions.

In March, Bank officials announced a “conditional pause” to rate hikes, and they expect to remain on hold so long as inflation drops in line with their forecast. However, they have left the door open to further rate hikes if inflation and economic growth don’t ease as much as expected.

How do the Bank of Canada rate hikes affect average Canadians?

Most Canadians experience interest rates through mortgages, and through various forms of consumer debt, including credit cards, personal loans and auto loans. The prime rate, which commercial banks use to calculate interest rates on variable rate mortgages and home-equity lines of credit, has risen to 6.7 per cent, from 2.45 per cent in 2021. Interest rates for fixed-rate mortgages have also risen.

Higher interest rates will slow down the economy and increase unemployment. The most visible impact so far is in the housing market, where sales volumes and prices have fallen sharply. GDP growth stalled in the fourth quarter of 2022, but the labour market remains remarkably resilient. The Bank of Canada expects the economy to experience almost no growth through the first half of 2023, and Governor Tiff Macklem has said Canada could experience a “mild recession” this year.

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