Bank of Canada Raises Rates by 50 Basis Points

The Bank did acknowledge that tighter monetary policies aimed at controlling inflation are weighing on economic activity around the world, and as economies slow and supply disruptions ease, global inflation is expected to come down.

In Canada, in the last three months, CPI inflation has declined from 8.1% to 6.9%, primarily due to a fall in gasoline prices. But it’s not enough yet: “The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing,” the latest announcement said, “Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched,” it said in the press release, adding that CPI inflation is projected to move down to about 3% by the end of 2023, and then return to the 2% target by the end of 2024.

Canada’s Economic Growth Expected to Stall Through Middle of 2023

The Bank notes that the effects of recent policy rate increases by the Bank are becoming evident in interest-sensitive areas of the economy: housing activity has retreated sharply, and spending by households and businesses is softening.

“Also, the slowdown in international demand is beginning to weigh on exports. Economic growth is expected to stall through the end of this year and the first half of next year as the effects of higher interest rates spread through the economy. The Bank projects GDP growth will slow from 3¼% this year to just under 1% next year and 2% in 2024,” it said. 

“In Canada, the economy continues to operate in excess demand and labour markets remain tight. The demand for goods and services is still running ahead of the economy’s ability to supply them, putting upward pressure on domestic inflation,” the Bank said, “Businesses continue to report widespread labour shortages and, with the full reopening of the economy, strong demand has led to a sharp rise in the price of services.” 

Bank of Canada Projects Global Growth Will Slow

The Bank notes that in the United States, labour markets remain very tight even as restrictive financial conditions are slowing economic activity.

“The Bank projects no growth in the US economy through most of next year. In the euro area, the economy is forecast to contract in the quarters ahead, largely due to acute energy shortages. China’s economy appears to have picked up after the recent round of pandemic lockdowns, although ongoing challenges related to its property market will continue to weigh on growth,” it said.

“Overall, the Bank projects that global growth will slow from 3% in 2022 to about 1½% in 2023, and then pick back up to roughly 2½% in 2024,” the note said. 

When Will the Hikes End?

Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Bank of Canada Governing Council expects that the policy interest rate will need to rise further. “Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding,” the Bank said.

RBC Economics thinks the Bank of Canada will be in a position to pause interest rate hikes by the end of the year. “We expect the overnight rate to end the year at 4%. But risks to that assumption are still tilted to the upside and are contingent on broader inflation trends showing further evidence of slowing,” RBC Economics said in a note. "Rising rates, especially given the year's dismal returns on both stocks and bonds and the erosion of spending power via elevated inflation, is rightly a concern for investors. Investors are urged to remember that a laser-sharp focus on time horizon and appropriate asset allocation is a more productive use of time than fretting over short-term market volatility,” said Morningstar Canada’s Director of Investment Research Ian Tam.

“That said, Canadians with outstanding mortgages should certainly pay attention to increasing rates and ensure that monthly cashflows are enough to cover the inevitable bump in mortgage payments either now (for floating rate mortgages) or in the future (when fixed rates mortgages renew)," he adds. 

Could We Have a Recession in 2023? Maybe, Maybe Not.

RBC Economics expects a moderate recession in the first half of next year. Morningstar expects a 50% likelihood of a recession in 2023.

“Inflation has remained stubbornly high, while economic activity continues to trend up. This points to a more aggressive stance from the Federal Reserve, which has led interest rates to soar higher. In turn, higher interest rates will lead to weaker gross domestic product growth in 2023 than we previously expected. A recession now looks like a 50% likelihood between now and the end of 2023,” said Preston Caldwell, Head of U.S. Economics for Morningstar Research, adding that he expects growth to accelerate again in 2024.