The central bank introduced an unexpectedly large rate jump, its biggest since 1998
The Bank of Canada had long indicated that more aggressive action on interest rates was coming down the line – but still caught most observers on the hop with a 1% benchmark rate hike on Wednesday, a bigger move than markets had been expecting.
That decision reflected its intention to “frontload” the way to higher rates, the central bank said, with inflation remaining more persistent than it had envisaged in April and further hikes imminent.
It means the Bank’s target for the overnight rate is now 2.5%, having risen sharply in recent months from the rock-bottom levels of the COVID-19 pandemic – and its messaging indicated that the inflation crisis shows little sign of abating.
Inflation is likely to hover around 8% in the coming months, the central bank said, as domestic price pressures begin to ramp up and global issues such as the Russia-Ukraine war and supply chain snarls continue.
While expectations of an oversized hike had risen in the weeks leading up to the announcement, markets had largely been preparing for an increase of three-quarters of a basis point.
Still, a 1% hike was consistent with the Bank’s strong language on interest rates and inflation in recent months, according to James Laird (pictured top), Ratehub.ca co-CEO and president of CanWise mortgage lender.
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He told Canadian Mortgage Professional the hike could be a good move in the long run, helping the central bank reach its target endpoint quicker than expected and bring some certainty to the market.
“At the beginning of June, [the Bank] used some pretty strong language about raising rates sharply to fight inflation. They increased them a little more than expected – but 100 [basis points] is in line with what they’ve been telling us,” Laird said.
“I actually want them to get to where they think they need to be to fight inflation and then hold there for a bit, because I think that’s what brings stability back to the market, and just simply knowing what the rates are going to be for a period of time as opposed to people really not knowing where rates are going to end up.”
The Bank’s latest three policy rate announcements have been so-called “oversized” hikes: two by a half point, and the latest by one percentage point. With more increases in the cards this year, could the central bank have effectively normalized those larger moves, making them more likely than conventional 0.25% hikes in the coming months?
A further oversized hike is certainly a possibility for the next announcement, according to Laird. “Other than continuing some strong language, they really didn’t give us too much as to specifically where they want to get to,” he said.
“Is it 50 more [basis points]? Is it 150 more, is it 200 more? Or perhaps they’re not sure – maybe they’ve got to see the data and react to it. I think everything’s on the table for the remainder of the year.”
With the benchmark prime rate set to climb to 4.70%, variable rates will also increase – effectively meaning borrowers applying for those mortgages will have to qualify at their contract rate plus 2% under stress test rules.
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While that means the qualifying rate for variable-rate mortgages will rise to about 6%, there remains a sizeable spread between those options and fixed rates, Laird emphasized. “What’s interesting is that still the stress test will be lower for variable versus fixed by about 1%,” he said. “So people will still be able to afford more going with a variable rate.”
That said, while the announcement struck many as surprising, Laird emphasized that the bond market had not seen large movement immediately after the news, indicating that it might have been anticipating such a move – and that fixed rates may not spiral significantly upwards as a result.
“The bond market, at least so far, is looking like it had this size of an increase priced in – either [for] this announcement plus one, or maybe the market thought it was a possibility for this one,” he said.
The Bank’s next policy rate announcement is set to take place on September 07, with that nearly-two-month gap set to present some intriguing food for thought on what direction economic conditions are headed in.
“Now we’ve got a long period to see what inflation is going to do, and what the economy is going to do,” Laird said. “The next couple of announcements, but especially the next one, are going to continue to be fascinating.”
