The Bank of Canada gave markets a bit of a surprise when it didn’t raise its key rate on Jan. 26. It stated that the time for extraordinary COVID-19 support is over and multiple interest rate increases are coming.
Bank of Canada governor Tiff Macklem said the central bank is taking a very deliberate approach in transitioning monetary policy from one of providing emergency stimulus to one of raising interest rates.
“Interest rates will now be on a rising path. This is a significant shift in monetary policy, and we judged that it is appropriate to move forward in a deliberate series of steps,” Macklem said in his opening statement at the BoC’s press conference.
But due to Omicron dampening the economy in the first quarter, the BoC decided to keep interest rates unchanged for the time being.
The Bank of Canada is very sensitive to public opinion, says Carleton University business professor Ian Lee, who also said he was “surprised, but not shocked,” that the BoC didn’t raise rates on Jan. 26.
“They didn’t want to be seen to be raising interest rates when the Omicron pandemic is still playing out. And so I think that they thought, ‘Oh, well, we’ll just postpone it,’” he told The Epoch Times.
The central bank sent a clear signal that the pandemic’s extraordinary measures are no longer needed. It’s judging that “economic slack [is] now essentially absorbed” and said its governing council decided to “end its extraordinary commitment to hold its policy rate at the effective lower bound.”
Macklem said that the risks around the BoC’s inflation forecasts are “reasonably balanced” but that the central bank is more concerned about upside risks than downside risks.
The Bank of Canada forecasts inflation to average 4.2 percent in 2022—up from October’s forecast of 3.4 percent—and 2.3 percent in 2023, which is unchanged from October.
“Under the assumption that oil prices remain flat, the boost from higher gasoline prices should also fade in the coming quarters,” according to the central bank’s quarterly monetary policy report, released also on Jan. 26, which assumes the price of West Texas Intermediate remains around US$75 a barrel over the projection period, up to the end of 2023.
However, WTI traded at near a seven-year high of US$88 a barrel on Jan. 26, getting a boost due to Russia’s threats against Ukraine.
“Oil prices could spike higher. On the other hand, when we’ve seen in the past big increases in goods prices, it’s not unusual to see some actual reversal of those prices. If we actually saw a reversal, inflation would come down more quickly,” Macklem said in response to a question from The Epoch Times.
The governor added that one scenario that might lead to prices of goods falling would be a shift to services as pandemic restrictions are lifted and the economy opens up, for example when restaurants and gyms return to full capacity.
“So in that scenario, it’s not hard to imagine that you get actually some reversal of goods prices. We haven’t built any reversal of goods prices into our projection. If you do put them in the projection, inflation would come down faster than we’ve forecast.”
Rising Interest Rates
Lee says that businesses will be more acutely affected than consumers in a period of rising interest rates.
“A rate increase will bite or impact immediately on all business operating loans,” Lee said. “So the impact will be much more immediate and much more universal for businesses than for consumers.”
Businesses operating lines of credit are typically tied to the prime lending rate, which banks increase in sync with the central bank.
Lee says most consumer loans—such as credit cards, mortgages, and auto loans—are fixed-rate and some already have extremely high rates of interest such that they would not be affected by the BoC’s rate increases.
A Jan. 21 Angus Reid poll found that 57 percent of Canadians say it is difficult to feed their household, given the highest inflation seen in 30 years. The poll also found that debt is a major source of stress for a quarter (24 percent) of Canadians and that a rise in interest rates would have a major negative impact on household finances for a quarter (25 percent) of Canadians.
Financial markets had been expecting the BoC to raise rates more quickly, and with the announcement of no hike, the Canadian dollar weakened sharply against the U.S. dollar and bond yields moved lower.
Analysis varies on how many rate hikes 2022 will see and when the first hike will occur.
TD described the Bank of Canada’s move as a “hawkish hold”—“While today’s decision came as a surprise, it does not change our conviction that rates are headed to 1.00 percent by mid-2022,” TD said in a note to clients.
But RBC says the Bank of Canada will be more measured in hiking rates.
“We continue to think the market is over-priced for more than five rate increases in 2022, and the BoC’s patience today increases our confidence that the central bank won’t be overly aggressive in its pace of tightening,” said RBC senior economist Josh Nye in a note to clients.
Raising rates would also increase the costs of debt, of which Canadian households have in abundance.
“We continue to believe the bank should take a cautious approach in raising interest rates, to avoid aggravating underlying household debt and house price vulnerabilities,” said Oxford Economics’ director of Canada Economics Tony Stillo in a note to clients.
Stillo is of the view that the bank will begin raising rates in April and hike twice more by the end of the year. However, if Omicron passes more quickly and is less harmful to the economy than expected, the BoC could begin lifting rates as soon as March, he added.
While expectations are for multiple rate increases in 2022, Lee points out that even with four rate hikes, the central bank’s key policy rate would still be just 1.25 percent—the rate would still be extremely low by historical standards.
“We are in a period that is extremely abnormal, unprecedented,” he said.