While most economists were not expecting the move, some now say one hike won’t be enough and additional increases might be coming later this summer.
The central bank raised its benchmark interest rate to 4.75 per cent on Wednesday, an increase of a quarter-percentage point in its first hike since January. The policy rate, which sets the cost of borrowing in Canada, now stands at its highest level since May 2001.
The Bank said in a statement accompanying the decision that policymakers felt the previous rate of 4.5 per cent was “not sufficiently restrictive” to bring inflation back down to its two per cent target.
The return to rate hikes comes after two consecutive decisions in March and April when the Bank left its key rate unchanged.
Calls for another interest rate hike on Wednesday had been growing amid a series of strong economic releases, but most economists surveyed by Reuters had expected the Bank of Canada to remain on the sidelines in June.
The central bank had said it would keep its rate hikes on pause until it saw an “accumulation of evidence” that its policy rate was not restrictive enough to bring inflation down to two per cent.
The Bank of Canada used that same phrase — “accumulation of evidence” — in a statement Wednesday to describe how demand in the economy “looks to be more persistent than anticipated.”
Following a series of monthly declines, the annual inflation rate ticked up to 4.4 per cent in April from 4.3 per cent in March.
Canada’s economic output also came in stronger than expected in the first quarter of the year and the country’s labour market has shown little signs of weakness.
The Bank of Canada said in its statement Wednesday that it still sees inflation reaching three per cent sometime this summer as last year’s substantial price gains “fall out” of the annual data, but the central bank did not reference its earlier prediction that inflation would reach two per cent sometime in 2024.
Amid the strong economic backdrop, the Bank said that it was growing more concerned that inflation could get stuck “materially” above two per cent.
“The bank is focussed on one thing and one thing alone, and that is getting inflation back to two per cent,” Jim Stanford, economist and director of the Centre for Future Work, tells Global News.
“And it’s clear that that’s not happening fast enough for the banks liking.”
Bank of Canada might not be done yet, economists say
Economists who spoke to Global News had expected the Bank of Canada would wait until July before potentially raising interest rates so that it could see whether the economy slowed sufficiently in the weeks ahead.
CIBC senior economist Katherine Judge said in a note to clients that the Bank of Canada was nonetheless “justified” in delivering the quarter-point rate hike on Wednesday.
She said another rate increase was in the cards in future decisions, but noted that the central bank removed earlier language in its statement about being prepared to raise the policy rate further if needed.
Benjamin Reitzes, BMO’s managing director of Canadian rates and macro strategist, said in a note however that if economic data continues to come in strong over the next few weeks, another 25-basis-point rate hike at the Bank of Canada’s next decision on July 12 “looks likely.”
Economists from both TD Bank and RBC echoed BMO’s call that additional hikes could be in the cards this summer unless Canada’s economy shows signs of cooling off.
This coming Friday marks the first of two Labour Force Survey releases before the July decision, and the Bank of Canada will have another inflation reading, updated GDP figures for April and a new business outlook survey to consider.
Even without clear language suggesting a “tightening bias,” RBC senior economist John Nye said in a note that if the Bank of Canada felt 4.5 per cent wasn’t restrictive enough, 4.75 per cent likely won’t be, either.
In Stanford’s opinion, the central bank’s tightening campaign is focused on getting inflation back down to two per cent too quickly at the expense of Canadian households. He says consumers should be prepared to keep tightening their belts until the Bank of Canada’s policymakers signal they’re satisfied with inflation’s trajectory.
“This latest hike is to send the message that they are going to keep this battle raging against inflation,” Stanford says.
Mortgage pain about to intensify
Wednesday’s rate hike will soon be felt on the pocketbooks of Canadian homeowners with variable-rate mortgages or those set to renew their fixed terms.
While some variable-rate mortgage holders will immediately see their monthly payments increase in line with the rate decision, those with fixed payments could see the amortization of their loan extend once more.
James Laird, co-CEO of Ratehub.ca, said in a release Wednesday that these mortgage holders will likely hit their trigger rate soon, if they have not already. This is the point at which a variable mortgage holder’s payments are no longer covering any principal loan and are going directly to interest alone, which can prompt the need for additional payments to get back on track with their lender.
Fixed mortgage rates, which are tied to Canada’s bond market, were already trending up in anticipation of Wednesday’s decision and will continue to rise following the hike, Laird said. Bond yields are now at their highest point since 2007, he added.
Based on market rates for homes and variable mortgages in April, the average homeowner’s payment on a five-year variable-rate mortgage will rise to $4,173 after Wednesday’s hike, up from $4,075 previously, according to Ratehub.ca’s calculations.
Laird said that the increase to the Bank’s key interest rate will put downward pressure on home prices, which were rising in some markets in the months leading up to the decision.
A small step in the Bank’s policy rate might not have a pronounced impact on the rebounding Canadian housing market, though says Royal LePage chief operating officer Karen Yolevski.
Buyers returning to the housing market this spring have been competing over a limited inventory of properties, putting upward pressure on prices. An RBC analyis released Tuesday showed sellers were also emerging from the woodwork in May, though not yet to a degree that would balance the strong demand and limited supply.
Given the current conditions, one rate hike is likely not enough to send the market back into the correction it faced after the Bank of Canada’s series of oversized rate increases in the past year, Yolevski tells Global News.
“It might have a slight impact on the market,” she says of Wednesday’s increase.
“It’s likely to be status quo unless we continue to see these rates increase like we saw last year.”
Freeland says strong job market offsetting rate pain
Finance Minister Chrystia Freeland was asked by reporters Wednesday about the burden another rate hike puts on Canadians with mortgages or those struggling to enter the housing market.
“There are a lot of Canadians who are anxious right now and who will be concerned when they see this step taken by the Bank of Canada,” she said in response.
Freeland, however, pointed to the “resilience” of the Canadian economy and booming jobs market as offsetting the pain caused by higher interest rates.
“Having a good is the key to the well-being of every single Canadian and their family. It’s the key to being able to pay your rent or your mortgage,” she said.
The deputy prime minister said that price pressures are still trending in the right direction and that “stable, low inflation” is the destination.
Conservative Party Leader Pierre Poilievre said in a speech to caucus on Wednesday morning that the country’s household debt load, which the Canada Mortgage and Housing Corp. says now matches the size of the country’s economy and is the largest among G7 nations, is “on the verge of becoming a crisis.”
He cited an International Monetary Fund report from last week that flagged Canada alongside Australia, Norway and Sweden as countries most at risk of defaults tied to higher mortgage payments.
Poilievre blamed the Liberal government’s budgetary deficits and expectations that the Bank of Canada’s rates would stay lower for longer as home prices boomed during the pandemic as a key source of instability.
The Conservative leader said that while the government does not set the interest rate, he argued its spending decisions can act as fuel for inflation, which forces the Bank of Canada to raise its policy rate.
Asked whether higher-than-anticipated government spending in the 2023 federal budget was a concern she had discussed with Bank of Canada governor Tiff Macklem, Freeland reiterated that Ottawa and the central bank operate independently in setting fiscal and monetary policy but have “clear lines of communication.”
— with files from Global News’ Kyle Benning