economists do not believe bank of canada ready to put the brakes on its interest-rate-hike cycle for now, even though there are growing signs that inflation is coming down and the economy is softening.
With Canada’s central bank expected to announce its eighth consecutive rate hike on Wednesday, most commercial banks have predicted quarter-percentage point increases. That would take the central bank’s key interest rate to 4.5 percent, its highest since 2007.
Although headline inflation slowed significantly last month, Royce Mendes, managing director and head of macro strategy at Desjardins, said the labor market is still hot and underlying inflation pressures are still “sticky.”
“I think (the bank) will use this to justify further rate hikes,” Mendes said.
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Last month, the unemployment rate fell to five percent, slightly above the all-time low of 4.9 percent.
After raising rates again in December, the Bank of Canada indicated it was open to tapering its aggressive rate-hike cycle based on upcoming economic data releases.
The Bank of Canada is likely encouraged that headline inflation is slowing. After reaching a peak of 8.1 per cent in the summer, the annual inflation rate has come down to 6.3 per cent in December.
However, Mendes noted that core measures of inflation, excluding more volatile items such as food and gas, eased only slightly last month.
For months market watchers have been trying to predict when the central bank will be ready to stop raising rates, with some holding out hope that December’s rate hike will be the last. This time, however, most forecasters seem to agree on a January increase, saying that next week will be the last increase of the cycle.
Mendes said that although he expects this to be the last hike for now, Canadians shouldn’t be too confident that interest rates won’t go up further.
“The Bank of Canada needs to make sure it has done enough to get inflation back toward the two per cent target. And that’s not clear right now,” he said.
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TD director of economics James Orlando said the Bank of Canada may not back down too much in its announcement next week even if it intends to hold off on raising rates.
Orlando expects the Bank of Canada to say it does not need more rate hikes, but will continue to monitor how economic conditions develop. Thus, the door is open for further rate hikes if needed, he added.
“Obviously, if things get out of hand … they may have to raise rates again,” Orlando said.
Since March, the Bank of Canada has embarked on one of the fastest rate-hike cycles in its history. After slashing interest rates to near-zero during the pandemic to stimulate a declining economy, it raised rates sharply in 2022 to rein in skyrocketing prices.
The increase in rates has already slowed down the housing market significantly and is expected to affect the economy more broadly over time. Businesses and consumers facing higher borrowing costs will pull back on spending, which will reduce demand in the economy and put downward pressure on prices.
Yet so far, economists say the decline in inflation is due to things outside the Bank of Canada’s control, such as lower energy prices.
This means that the full brunt of the hike in interest rates is yet to be felt. Mendes said the Bank of Canada is trying to balance the risks of raising rates too high or too low.
“It’s a very difficult balancing act,” he said.
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The Bank of Canada will also release its quarterly monetary policy report on Wednesday, which will provide updated forecasts for economic growth and inflation.
As the Canadian economy reacts to higher interest rates, many economists are saying that Canada will enter a mild recession this year.
While there is no evidence of a recession yet, there are signs that higher interest rates and inflation are taking a toll on firms and consumers.
This week, the Bank of Canada released its business outlook and consumer expectations survey, showing firms’ confidence is waning and Canadians are cutting back on spending to offset bills on essential goods.
At the same time, inflation expectations were still relatively high in surveys.
“This suggests the bank may want to err on the side of a little more tightening in the near term,” Mendes said.
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