Canadians brace for another rate hike Wednesday

Governor Tiff Macklem and Senior Deputy Governor Carolyn Rogers answer reporters’ questions following the policy rate decision and the release of the Monetary Policy Report. / Le gouverneur de la Banque, M. Tiff Macklem, et la première sous-gouverneure, Mme Carolyn Rogers, répondent aux questions des journalistes sur la décision relative au taux directeur et le Rapport sur la politique monétaire.

The Bank of Canada took it most aggressive step yet to temper rapid inflation, delivering a one per cent interest rate hike and signalling it’s willing to take economically painful measures to get consumer prices under control.

Governor Tiff Macklem and his team of economists announced the rate hike on Wednesday morning, bringing the overall rate to 2.5 per cent.

This is the fourth time the Bank of Canada has lifted interest rates since March, part of a campaign designed to make it harder for Canadians to borrow money in order to slow the pace of spending and deflate sectors of the economy that experienced frenzied consumer activity during the COVID-19 pandemic, such as the housing market.

While the approach aims to cool off an economy where consumer prices have grown at an alarming pace, it has also sparked fears of collateral damage — that the high cost of borrowing could tip the economy into a recession. As economic growth stalls, businesses are forced to freeze hiring and cut costs, often provoking a spike in the unemployment rate.

Last week, RBC predicted a “moderate” recession by 2023 that sends the unemployment rate to around 6.6 per cent as a result of high interest rates.

Research released on Monday by the Canada Mortgage and Housing Corporation estimated that Canada’s unemployment rate — now at a record low of 4.9 per cent — will rise to between 6.2 per cent and seven per cent in early 2023 as a result of weaker economic conditions.

But central bankers have made it clear that their overwhelming priority is lowering inflation to two per cent — a target that is well below recent inflation levels. Economic data shows that inflation hit a 39-year high of 7.7 per cent in May, driven largely by the rising cost of energy, food and shelter.

Bay Street economists have said they expect to see inflation rise again when Statistics Canada releases the latest round of monthly data next week, but anticipate it will start to cool off later in the year as rate hikes continue.

Macklem told reporters in June that he believes the Canadian economy is in good shape to handle higher rates. Employment is up, business insolvencies are down, and households have amassed record savings, putting many Canadians in a comfortable position ahead of an economic downturn.

“The economy can handle — indeed needs — higher interest rates,” Macklem said last month. “Our goal is for a soft economic landing with inflation coming back to the two per cent mark.”

Some economists contend that there is little historical precedent for the Bank of Canada’s desired “soft landing” — a tricky manoeuvre where high interest rates help lower inflation without cratering the economy.

In the past six decades, the Bank of Canada has sought to combat rampant inflation with tough monetary policy three times — in the 1970s, ’80s and early ’90s — but each attempt has ended in a recession, according to a recent analysis from the Canadian Centre for Policy Alternatives.

“There is simply no historical precedent for the Bank of Canada engineering a ‘soft landing.’ Each time the Bank of Canada has attempted such engineering through rapid interest rate hikes — which it appears to be set on doing now — it has resulted in a crash landing,” said David Macdonald, senior economist at the CCPA and the author of the study.

The Bank of Canada kept interest rates at record lows through the pandemic, allowing consumers to spend widely and businesses to invest in operations while strict public-health restrictions threatened Canadian jobs and economic prosperity.

The first rate hike came in March, two years after the pandemic began, followed by two more hikes in April and June.

The central bank’s fear — and one that is shared by many independent economists — is that inflation, if left unchecked, will become a permanent feature of the Canadian economy, a self-fulfilling prophecy where consumers and businesses continuously drive up prices because they expect costs to keep rising.

Two recent Bank of Canada surveys reinforced that fear, showing that businesses and consumers are increasingly expecting inflation to move higher in the months ahead.

Following the most recent rate hike in June, Bank of Canada deputy governor Paul Beaudry indicated that the bank wants to stifle those expectations before it’s too late.

“History shows that once high inflation is entrenched, bringing it back down without severely hampering the economy is hard,” he told reporters. “Preventing high inflation from becoming entrenched is much more desirable than trying to quash it once it has.”


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