For the first time since bringing the benchmark rate to 0.25% at the start of the COVID-19 pandemic, The Bank of Canada has raised its key interest rate by a quarter percentage point to 0.5% to tackle inflation which is at its highest level since 1991.
Before the pandemic, the Bank’s rate was 1.75%, but it quickly slashed the rate down to 0.25% to help the economy.
On Wednesday, Bank Governor Tiff Macklem and his team of Economists increased the key interest rate despite disruption to the global economy due to the war in Ukraine.
Two years ago this week, the Bank of Canada first reduced its key policy rate to get in front of economic fallout from the emerging coronavirus crisis.
What followed after that were two more rate cuts in March 2020 that made the key policy rate to 0.25% ever since the economy has bounced back quickly.
On the 1st of March 2022, Statistics Canada released a report stating that the economy grew at an annual rate of 6.7%, faster than the Central Bank had forecast.
It suggested that demand will continue to test companies’ ability to keep up with orders, which is a recipe for further inflationary pressure. The actual gross domestic product is now above pre-pandemic levels.
In its announcement released on the 2nd of March, the Bank said, “The unprovoked invasion of Ukraine by Russia is a considerable source of uncertainty.
Oil and other commodities like fertilizer and natural gas have risen sharply. This increase will add to inflation worldwide and negatively impact confidence, and new supply could weigh on global growth.”
In its announcement, the Bank of Canada said it expects inflation to be higher in the near term than previously thought.
The Central Bank apprised that this week’s rate hike wouldn’t be the last, with economists expecting considerable increases before the end of the year. The Wednesday rate hike is the first in what analysts expect will be a quick succession of increases in the coming quarters that could bring borrowing costs back to pre-pandemic levels next year.
“Economic growth in Canada was robust in the fourth quarter,” the Central Bank said, adding that the number “confirms its view that economic slack has been absorbed.”
“This hike in interest rate was not the ‘dovish hike’ that some had expected,” economists at National Bank Financial said in a note. “With the Bank of Canada citing higher than expected growth and upside risks to inflation, it seems to appear that a steady dose of normalization continues to be in the cards.”
The recent invasion of Ukraine is putting further upward pressure on prices for commodities like energy and food-related commodities.
All told, inflation is expected to be higher in the near term than projected in January. Persistently elevated inflation will increase the risk that longer-run inflation expectations could linger upwards.
The Bank is ready to use its monetary policy tools to return inflation to the 2% target and keep inflation expectations well-anchored.
It warned on Wednesday that price increases have become pervasive, and inflation “is now likely to be soaring in the near term than projected in January.”
Avery Shenfeld, Chief Economist at the Canadian Imperial Bank of Commerce, said in a note to clients that the central Bank’s outlook for higher inflation means it will likely increase rates more quickly than previously expected.
“The odds are that the bank will show the remaining three quarter-point hikes we had allocated for 2022 in the next three rate-setting dates, instead of a spread out through the year,” he said.
Since 2018, interest rates have been going up for the first time, and some experts say that could make it difficult for Canadian households who are already struggling with heavy debt levels.
The Bank of Canada’s rate affects Canadian consumers’ rates on things like mortgages, lines of credit, and savings accounts at their banks.