Bank of Canada: Are further oversized hikes on the way?

Further 50-basis-point increases to the Bank of Canada’s benchmark rate could be in the cards in each of the next two policy rate announcements as it attempts to crack down on inflation, according to a prominent economist.

Doug Porter (pictured top), chief economist at BMO Capital Markets, told Canadian Mortgage Professional that the central bank could take an “aggressive” approach to rate hikes in its next meetings after raising that trendsetting rate in its March and April announcements.

“We are building in 50-basis-point increases in each of the next two meetings,” he said. “Effectively, we see the Bank of Canada getting back to 2% as quickly as they reasonably can – [and] they might be slightly overly aggressive.

“It is possible that instead, we’ll see a series of 25-basis-point increases through the rest of the year. But either way, we do think we’re going to have the Bank of Canada take interest rates up to 2% as quickly as they can and then slightly nudge it above 2% by the end of this year and into 2023.”

The Bank kept its policy rate at a resolutely low 0.25% during almost two years of the COVID-19 pandemic before introducing a quarter-point hike in March and a half-point increase last week, with the latter representing its single largest rate hike for over two decades.

Its most recent rate announcement was a “stern” one, Porter said, marked by strong language on Canada’s inflation crisis and the urgent need for further rate increases.

“There was definitely a feeling of concern by the Bank of Canada – but appropriately so, and given the circumstances, [it’s] not that surprising that the Bank would both sound a bit concerned and commit to raising interest rates further,” he said.

The Bank said its inflation outlook had seen a “substantial” upward revision from earlier expectations – and indicated that consumer price index (CPI) inflation, which is currently sitting at a three-decade-high, was only likely to return to its 2% target by 2024.

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Asked whether the Bank had gotten it wrong on inflation by opting to keep its benchmark rate so low for so long, Porter said missteps had arguably been made, although a worst-case scenario has certainly been avoided.

“I think there’s the general recognition that policymakers at least moderately erred, if not seriously erred, last year by keeping policy too loose for too long,” he said. “In some ways, it was understandable that if they were going to make a mistake, they’d lean that way.

“Arguably, it would’ve been even worse if they had tightened prematurely, and the economy had not held up as well as it did. That would have been a pretty awful mistake as well.”

Staying the course on the benchmark rate throughout the pandemic, Porter added, was a “probably a better mistake to make” than raising rates and keeping unemployment at an elevated level for a lengthy period.

The Bank’s latest hike means its benchmark rate has now increased by 0.75% in a matter of weeks, a development that’s likely to significantly change the housing market outlook for would-be buyers and Canadians hoping to refinance or renew.

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Those rate increases, and the fact that the central bank has already telegraphed further hikes down the line, are bound to result in a “chilling effect” of sorts for Canada’s runaway housing market, according to Porter.

“Just the fact that it is now clear to everyone that [the Bank] means business, that this is not just talk,” he said.

“That they’re willing to even go in half a percentage-point clumps, I think will send a pretty loud message to anyone out there looking to borrow or invest that they’re facing a notably higher interest rate environment in the months and quarters ahead.”

The fact that a number of major markets have started to see a significant shift in activity in recent weeks, he added, is largely because “both buyers and sellers do recognize that the interest rate landscape is changing as we speak.”

Still, that’s a sign of the market returning to a degree of normality rather than a significant cause for concern, Porter said, with national year-over-year average house price increases of nearly 30% a “very unhealthy” recent development.

“The one concern I would have is that it could feed on itself – especially if the Bank of Canada needs to continue raising interest rates for other reasons,” he cautioned.

“Let’s say wage pressures now start to really perk up or more commodity prices continue to rise further. The Bank of Canada may have to keep going even in the face of a notably weaker housing market.”