Bank of Canada "means business" on interest rates: CIBC's Tal

The Bank of Canada’s decision to hike its benchmark policy rate by half a percentage point shows that the central bank “means business” and is in a hawkish mood on interest rates, according to a leading economist.

CIBC World Markets deputy chief economist Benjamin Tal (pictured) told Canadian Mortgage Professional that further significant rate hikes from the Bank appeared to be on the horizon, particularly after it adjusted its neutral rate – the interest rate expected to keep inflation constant while supporting the economy at full employment – by a further 25 basis points.

“[The Bank] raised this neutral rate, which… gives them the green light to be a bit more aggressive than otherwise,” Tal said. “It gives them a little bit more room to raise [rates] faster.”

The Bank’s April 13 announcement marked its largest single rate increase in over two decades, with its 0.5% hike following a quarter-point raise in March after nearly two years at a rock-bottom 0.25%.

Unsurprisingly, inflation figured prominently in the announcement. The Bank indicated a “substantial upward revision” in its inflation outlook which it said was caused by supply chain snarls and price spikes across several commodities as a consequence of Russia’s continuing invasion of Ukraine.

The statement potentially paved the way for further oversized rate hikes down the line, according to Tal, as the Bank grapples with inflation that’s currently higher than it’s been in more than 30 years.

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While the central bank sounded a bullish tone on Canada’s economic prospects for this year and next, he noted it had effectively indicated that it needed to raise rates more quickly than originally envisaged.

“Another 50-basis-point [increase] could be in the cards; if not, they will go with 25 [in the next announcement],” Tal said. “Basically, they gave themselves the right to go another 25 basis points than originally thought, because they said the speed limit was actually not as low as it was before.”

Consumer price index (CPI) inflation could hover near 6% and is expected to return to the 2% target only by 2024, the Bank said, belying Governor Tiff Macklem’s confidence last year that inflation was likely a “transitory” phenomenon.

Still, while it’s undoubtedly been exacerbated by the supply chain issue caused by the crisis in Ukraine, Tal said raising interest rates would likely prove an effective measure against the inflation that the Bank of Canada is able to influence.

“A lot of it has to do with the supply story coming from Russia and the Ukraine situation. That’s something that they can’t control – they can raise interest rates to the sky, [but] that will not bring you more used cars or semiconductors,” he said.

“The point that I’m making, which is extremely important to understand, is that, until recently, the narrative about inflation was supply chain and goods inflation. But you can see now that inflation is more broadly based – all elements are rising, [including] services that are not connected to the supply chain.”

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That means that the Bank has more power to impact inflation by raising rates than if it were merely a supply chain issue, said Tal. “They cannot do much about the supply chain story – but they can do something about the demand side of the economy.”

Wednesday’s announcement means that the Bank’s trendsetting interest rate has now increased by 0.75% in the past month and a half, a development with implications for Canada’s housing and mortgage markets that are not lost on brokers.

Tal said some softening had been apparent in those markets even prior to the Bank’s latest announcement, with a further levelling off likely to occur in the coming weeks.

“Clearly this 50-basis-point increase will have an impact,” he said. “We have seen a lot of people frontloading activity ahead of that.

“I think that maybe we’ll have a few more weeks of good market, and then by the end of the spring, it will slow down notably – and that’s a good thing.”

It’s widely accepted that inflation will remain substantially elevated for the near future – and Tal said its trajectory in the final two quarters of the year will weigh heavily on the Bank’s plans for the benchmark rate for the remainder of 2022 and beyond.

“Inflation is stretching very close to peak,” he said. “But I think the rate at which it will slow down in the second half of the year will be crucial in terms of the policy.”