The Bank of Canada raises interest rates by 0.5% for the first time in more than 20 years and begins reversing quantitative easing measures in an attempt to align inflation.
The decision was telegraphed widely, but it still had an impact. After a 0.25 percentage point rise last month, the first since the start of the COVID-19 pandemic, Canada’s central bank on Wednesday raised its key overnight interest rate target to 0.5% to 1%. The monetary intervention instrument has not been lifted much at once since May 2000.
We have three main messages. Bank of Canada Governor Teff McClem said. First, the Canadian economy is strong. […] Second, inflation is very high. […] Third, we need higher interest rates. »
“We are committed to using our key rate to bring inflation back to target and will take strong action to achieve that, if necessary,” he explained, before adding, “Canadians should expect further increases.”
Which is that the central bank does not expect the rising cost of living to return to the 2% target anytime soon. At its highest level in 30 years in February, at 5.7%, inflation in Canada should maintain an average of about 6% in the first half of the year, before starting to decline gradually to 4.5% at the end of the year, to 2.4% in end of 2023 and finally to 2.1% at the end of 2024, the Bank of Canada now expects in A new version of the sound monetary policy report It was unveiled on Wednesday.
The rise in Canadian policy has led to higher interest rates for the country’s banks and other lenders. By making borrowing more expensive and saving more useful, a higher policy rate discourages spending and investment and thus reduces aggregate demand in the economy.
The Bank of Canada did not raise its key interest rate only on Wednesday.
Having been quickly prevented from lowering interest rates because they were at zero, during the crisis it turned to measures of “quantitative easing”, that is, pumping liquidity into the economy through the massive purchase of financial assets, including government bonds. Thus, its balance sheet nearly quadrupled to nearly 500 billion when it decided, last November, to content itself with maintaining its stability.
On Wednesday, it went even further by announcing that it would not replace maturing bonds, which should rapidly shrink its balance sheet, with 40% of its bonds due in the next two years.
All of these measures intended to cool economic activity come at a time when the current spike in inflation is due, among other things, to an increase in demand from Canadian consumers that is stronger than businesses are able to meet, particularly in the housing sector. , says the Bank of Canada.
But it is “mainly” driven by rising international prices for oil, food, commodities and durables due to factors such as the global economic recovery, supply chain issues and the invasion of Ukraine by the coronavirus by Russia. This terrible crisis alone, which “causes unimaginable human suffering,” is adding 0.7 percentage points to inflation in Canada, the bank calculates.
However, the latter considers it necessary to increase the cost of money in the country to “adjust domestic demand”, but also to prove to Canadian businesses and consumers that they can trust it when it says inflation is its “top priority” and that it intends to bring it back to its 2% target.
“We need higher interest rates to keep Canadian inflation expectations well anchored, so that domestic inflation returns back to target when global inflationary pressures are […] Teff McClem explained.
Beware of debt
After that, “the economy can afford it,” the governor said. It has “surmounted the Omicron wave remarkably well”, the unemployment rate is “at a historic low”, the lifting of health measures allows more spending on services, exports will benefit from higher commodity prices, and business investment is expected to increase. The bank also expects slightly stronger economic growth this year than expected in January (4.2% instead of 4%), after which it will slow gradually in 2023 (3.2% instead of 3.5%) and in 2024 (2.2%).
Knowing that Canadians are heavily indebted, we promise to monitor the impact of higher interest rates on their ability to repay their debt. In a press conference, Deputy Governor Carolyn Rogers explained that there are two factors that reduce the risk of mistakes. First, the health rules in place during the pandemic have had the effect of increasing Canadians’ savings, leaving them with a small financial cushion to cushion the shock. She pointed out that the rise in interest rates then starts from a very low level. Much lower than the levels used in the stress tests that borrowers must pass when obtaining a mortgage.
At 1%, the Bank of Canada’s key rate is still far from the pre-pandemic level of 1.75%. In fact, the bank believes that the key rate will continue to stimulate growth until it returns to the range of 2% to 3%, which is called the “neutral rate”.
Where will you stop?
“If demand is responding quickly to higher rates and inflationary pressures ease, it may be appropriate to pause the tightening once we get close to neutral and hold stock,” said Teff McClem. On the other hand, we may need to raise interest rates a little above the neutral rate for a while in order to restore the balance between supply and demand and bring inflation back to target.
For National Bank analysts, there is no doubt that the Bank of Canada will continue its momentum and that its key rate will be at least 2% at the end of the year. Bank of Montreal’s chief economist, Douglas Porter, thinks we’ll do it again immediately with one, maybe even two more increases of 0.50 percentage points, to finish the year at 2.25% and go to 2.75% in 2023. CIBC colleague Avery Shenfield thinks, For his part, we will be more cautious and that we will stop at 1.75% this year and 2, 25% next year.
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