“They are telling you, ‘We have done most of the job, but it’s not done yet'”

By Fergal McAlinden 27 Oct 2022Share

The Bank of Canada’s latest interest rate increase may have been lower than markets had expected – but the central bank is still “losing sleep” over inflation and not finished on rate hikes, according to a prominent economist.

Benjamin Tal, deputy chief economist at CIBC, told Canadian Mortgage Professional that the Bank’s decision on Wednesday to increase its benchmark policy rate by 50 basis points, rather than the 75 anticipated by markets, showed that it was nearing the end of its series of hikes, but still had a way to go.

“The narrative is the same: that inflation is an issue and they’re starting to lose sleep over inflation, there’s no question about it,” he said. “Basically, what they’re telling you is they’re not done.

“Although the market expected 75 [basis points] and the Bank of Canada delivered 50, it doesn’t mean that they will stop. In fact, they’re telling you ‘We are not going to stop.’”

The Bank’s announcement means that its trendsetting interest rate now sits at 3.75%, having risen by a full 3.5% so far in 2022 after remaining consistently low throughout the first two years of the COVID-19 pandemic.

Wednesday’s hike was its sixth consecutive increase, and the fifth so-called “oversized” jump, of more than 25 basis points, this year.

Read more: Bank of Canada makes another big rate hike

A further increase is expected at the Bank’s final rate decision of the year, set to be revealed on December 7, with Tal indicating that either a quarter-point or 50-basis-point jump is likely.

That would mean the terminal rate at the end of 2022 would settle at either 4% or 4.25%, a point beyond which the central bank risks triggering a deeper recession than currently anticipated, according to the economist.

Having pursued an aggressive policy of rate hikes during the summer that included a surprise one-percentage-point increase, the Bank is now using slightly more balanced language on its benchmark rate, Tal said, perhaps because it’s nearing a point it doesn’t want to go beyond.

“What they’re telling us between the lines is that they don’t want to overshoot. They’re very well aware of the risk of overshooting,” he said. “They know that interest rates have gone dramatically higher very quickly, and they are frontloading activity. So they are telling you, ‘We have done most of the job, but it’s not done yet.’”

Inflation concerns

While the annual rate of inflation in Canada has slowed for three consecutive months after hitting a near-four-decade high in July, its downward pace has been milder than expected.

In September, that rate ticked down marginally over the previous month, although it was still higher than most economists had predicted (6.9%, compared with an anticipated 6.8%) with food prices surging.

The Bank of Canada will hope to hit pause on rate hikes after December to see the impact its 2022 trajectory has had on the economy, but it may have to intervene again if inflation doesn’t subside further at the start of 2023 as hoped – a situation the central bank would certainly rather not find itself in, according to Tal.

Read more: Could rising interest rates crash Canada’s housing market?

“If inflation does not behave in the first and second quarters of the year, they will have to go in again,” he said. “And that’s their nightmare scenario – that would be overshooting but putting the economy into a more significant recession. So that’s what they’re trying to avoid.”

That said, the Bank’s less hawkish language indicated that it believes it has more flexibility now, with most of the heavy lifting done on interest rates and less of a sense of urgency to hike borrowing costs, Tal said.

“It’s interesting that they decided to go with 50 [basis points] over 75,” he said. “The market gave them a green light to go 75. They didn’t, and that’s an interesting thought.

“I think that the Bank tried to make sure that they are not overshooting and tried to buy some time to assess the situation, but they’re telling you very clearly that it’s not over.”

When it comes to the slowdown that’s gripped Canada’s housing market over recent months, meanwhile, there’s little chance of the bottom falling out, according to Tal.

“This is not a crash. This is not a meltdown,” he said. “This is a very healthy correction.”