The Bank of Canada suggests more rate hikes are on the way. Will they trigger a recession?

The Bank of Canada’s latest interest rate decision has reinforced fears that the economy is headed for a recession that could cost some Canadians their jobs and keep worker wages stagnant.

Central bankers took their most aggressive step yet to try to tame rapid inflation on Wednesday, raising the bank’s key policy rate by a full percentage point and surprising private sector economists who expected a more moderate approach.

In making the announcement Wednesday morning, Governor Tiff Macklem acknowledged that the move was unusual, but said “it reflects very unusual economic circumstances.”

Consumer prices are at their highest levels in decades. Inflation grew to 7.7 per cent in May and is expected to hover around eight per cent for the coming months — far above the bank’s target range of two per cent. If left unchecked, the cost of living will turn into an affordability crisis for average Canadians, Macklem warned.

Low inflation “gives people predictability — to plan their spending and savings decisions, to budget, to live their lives without having to worry about what things are going to cost next week, next month or next year,” he said.

But the path toward low inflation is similarly treacherous. The higher the interest rates, the harder it is to borrow money, meaning consumers will spend less on major purchases while businesses curb operational investments. As economic growth slows, businesses are typically forced to freeze hiring and cut costs, often provoking a spike in unemployment.

With the Bank of Canada poised to drive interest rates even higher in the coming months — its next interest rate decision is coming in September — a growing number of economists are forecasting a tough road ahead for workers.

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.

By forcing businesses to slow expansion and cut costs, workers will likely find it increasingly difficult to negotiate raises, part of the central bank’s plan to prevent a “wage-price spiral” where workers demand increasingly higher pay to keep up with an increasingly high cost of living.

“If a whole bunch of people lose their jobs, not a lot of folks are going to want to ask for raises. In a labour market where unemployment is seven or eight per cent, workers just don’t ask for raises. It isn’t the right economic condition,” said David Macdonald, an economist with the Canadian Centre for Policy Alternatives.

The Bank of Canada has downplayed fears of a recession, contending that Canadians are well-equipped to handle higher rates and fasten their wallets. Employment is up, business insolvencies are down, and households have amassed record savings that put many Canadians in a comfortable position to withstand an economic downturn.

At Wednesday’s meeting, Macklem doubled-down on the bank’s goal of engineering a “soft landing” — a tricky manoeuvre where high interest rates help lower inflation without cratering the economy.

The bank is delivering severe rate hikes now in the hopes that, when the bank decides whether to hike rates again later this year, they can be more moderate than they were in July, he said.

“By front-loading interest rate increases now, we are trying to avoid the need for even higher interest rates down the road. Front-loaded tightening cycles tend to be followed by softer landings.”

But even with lighter rate hikes, some economists note that there is little historical precedent for a successful soft landing. 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. Each attempt has ended in a recession that resulted in higher unemployment and lost jobs, according to a recent analysis from the Canadian Centre for Policy Alternatives.

In the worst of those recessions, between 1981 and 1983, the employment rate fell by 4.2 per cent. With today’s population, the study found, that drop would be the equivalent of putting 1.3 million Canadians out of work.

“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 Macdonald, who authored the study.

In a note to clients, RBC economist Josh Nye said the bank’s desired soft landing “will be difficult to achieve.”

“Our forecast now assumes a mild recession next year,” he wrote.

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

The bank will announce its next interest rate decision on Sept. 7.


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