Bank of Canada surprises with 100-bp rate hike, largest in decades
The Bank of Canada on Wednesday raised its benchmark interest rate by a full percentage point, surprising markets with its biggest rake hike since 1998 in a bid to tame soaring inflation.
The central bank, in a regular rate decision, raised its policy rate to 2.5% from 1.5%, and said more hikes would be needed. The move was more forceful than the 75-basis point increase economists and money markets had forecast.
“An increase of this magnitude in one meeting is very unusual. It reflects very unusual economic circumstances,” Bank of Canada Governor Tiff Macklem said at a news conference.
“By front-loading interest rate increases now we're trying to avoid the need for even higher interest rates down the road. Front loading tightening cycles tend to be followed by softer landings,” he added.
The move makes it the first G7 central bank to increase rates by 100 basis points in this cycle. It follows a 75-basis point rate hike by the U.S. Federal Reserve last month.
In its statement announcing the hike, the Bank of Canada raised its near-term inflation forecasts and made clear it expects price gains to go higher, averaging around 8% in the middle quarters of 2022. Canada's inflation rate hit 7.7% in May, near a 40-year high.
The central bank now sees inflation averaging 7.2% this year, falling to about 3% by the end of 2023 and then back to the 2% target by the end of 2024.
“Of course, the Bank of Canada makes its decisions independently and is working very hard to counter inflation,” Canadian Prime Minister said after the rate increase was announced.
“At the same time, however, we have to highlight… how the Canadian economy has recovered and bounced back from the pandemic,” he added, citing a recovery in jobs since the start of the coronavirus pandemic.
Trudeau, who was speaking at an event to announce the deal to open a new electric vehicle battery plant in Ontario's Loyalist Township, said the Canadian economy continues to face headwinds from global forces such as the disruption of supply chains and the war in Ukraine.
The Bank of Canada has been playing catch-up for months after significantly underestimating the persistence of inflation.
But the move combined with the promise of more coming could spook markets, said economists.
The policy rate is now at the nominal neutral rate - the midpoint between 2% and 3% - where monetary policy is neither stimulative nor restrictive.
The Canadian dollar CAD= was trading 0.4% higher after the news at 1.2970 to the greenback, or 77.10 U.S. cents.
The Bank of Canada noted a "sharp slowdown" in Canada's housing market was underway, with that contraction expected to continue this year and into 2023.
Economic growth is now expected to be lower this year, with gross domestic product rising 3.5%, then slowing to 1.8% in 2023.
The slower growth is "largely due to the impact of high inflation and tighter financial conditions on consumption and household spending," the bank said. Its baseline forecast is for a soft landing, with no recession over the next three years.