The Bank of Canada is indicating that it may need to raise its policy rate to 3% or more to control consumer price growth and prevent Canadians from expecting persistently high inflation.
The central bank on Wednesday announced its second consecutive half-point rise in interest rates, which raised the reference rate to 1.5 percent.
Bank officials have previously said they intend to reach the benchmark rate at a “neutral” level of between 2% and 3% relatively quickly. In a speech on Thursday, Deputy Governor Paul Beaudry said there is a growing likelihood that the bank will have to move to the upper end of that range or higher.
“Price pressures are widening and inflation is much higher than we expected and is likely to be even higher before it is released,” Beaudry said, according to the prepared English version of a speech. at the Gatineau Chamber of Commerce.
“This increases the likelihood that we may have to raise the policy rate to or above the neutral range to balance supply and demand and keep inflation expectations firmly anchored.”
The Bank of Canada is in the midst of an aggressive cycle of rate hikes aimed at slowing the pace of inflation, which hit a new 31-year high of 6.8% in April. On Wednesday, he said he was “ready to act harder if necessary” to control inflation. Analysts felt that this meant that the bank was open to a possible 75 basis point rate hike, which would be the largest rate hike since the 1990s.
“When we talk about ‘more forceful’, we are obviously trying to think of both in terms of rhythm [of interest rate hikes] and level, “Mr Beaudry said at a news conference after the speech.
“This could involve making more movements in a row, or it could involve more movements. It will all depend on exactly what data you enter. We’re not doing anything with autopilot,” he said.
Higher interest rates cannot do much to deal with international sources of inflation, which include persistent supply chain bottlenecks, COVID-19 blockades in China, and rising prices. raw materials after the invasion of Ukraine by Russia.
But rising borrowing costs will reduce demand for the Canadian economy. This is important because consumer prices are rising more and more due to internal factors, as demand exceeds supply in Canada’s overheating economy.
“Demand-driven domestic inflation occurs when households and businesses are willing to buy more goods and services than the economy can produce. If left unchecked, it can open the door to persistently higher inflation.” said Beaudry in his speech.
The central bank’s main concern is to ensure that inflation expectations do not fall short. Where people think consumer prices are headed has a significant impact on where they end up. Companies set prices and employees negotiate wages based on their beliefs about inflation, which can create a kind of self-reinforcing cycle.
“The longer inflation stays well above our target, the more likely it is to feed inflation expectations, and the greater the risk that inflation will meet on its own,” Beaudry said.
“History shows that once high inflation is consolidated, it is difficult to bring it back down without seriously disrupting the economy. Preventing high inflation from tightening is much more desirable than trying to suppress it once it has done so.” , he said.
Royce Mendes, head of macro strategy at Desjardins Capital Markets, said in a note to clients that it could be difficult for the bank to get its policy rate close to 3% or more.
“The Canadian economy is extremely sensitive to interest rates, which could limit the number of additional rises needed to cool demand. With the housing market already showing signs of softening, our view is still that the Bank Canada will not be able to raise rates above 2.25 per cent, “Mendes wrote.
“Remember that in the last cycle the central bank told a similar story about raising rates to the 3 per cent range, but it was only able to push the policy rate to 1.75 per cent. at the time, the housing market and consumer spending began to weaken so drastically that rate cuts were on the table even before the pandemic. “
The speech of Mr. Beaudry also provided the Bank of Canada’s clearest explanation so far as to why it waited until the spring of 2022 to start raising interest rates. This decision has been criticized by private sector economists who say the bank took a long time to start tightening monetary policy, especially when it became clear in the autumn of 2021 that high inflation would not be transitory.
Beaudry said the bank was weighing the risks and making decisions based on how inflationary shocks had occurred in the past. He said there were several reasons why he slowed the rate hike.
On the one hand, much of the inflationary pressure in the summer and fall of 2021 came from international forces linked to bottlenecks in the global supply chain and oil prices. “Inflationary shocks from abroad are often temporary,” Beaudry said.
“Second, for most of 2021, the economy was operating well below capacity, so there was no oversupply. Finally, amid successive waves of pandemics, we knew that a premature hardening could prevent the ability of people who lost their jobs during the pandemic to find work again, “he said.
There was always the risk that inflation would be more persistent than the bank predicted and would be entrenched, Beaudry said. But he said “it seemed appropriate to take that risk at the time, given the weak economy and the view that supply-side sources of high inflation are likely to be temporary.”
“The situation today is remarkably different,” he said.
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