Bank of Canada: was latest rate hike too aggressive?

Canada’s housing market has seen a pronounced cooldown amid rising interest rates this year – and the Bank of Canada’s latest decision risks sparking an even greater decline in home prices, according to a Bank of Montreal (BMO) economist.

Benjamin Reitzes (pictured), BMO’s managing director, Canadian rates and macro strategist, said the central bank’s 100-basis-point hike was “a surprise” and that it had shown a hawkish approach in introducing a rate jump of that extent.

“The bank’s aggressiveness here was a bit unexpected, given they have told us in the past that they didn’t really want to create unwanted volatility in the markets, and that’s what these kind of surprise moves do,” he told Canadian Mortgage Professional.

“It’s going to make it that much more challenging and it’s going to make things that much more challenging, much sooner. We’re already looking for home prices to pull back pretty notably, and now the risks are that they may decline even further and even faster – and then we’ll see where rates end up.”

The Bank had been expected to hike its benchmark rate by 75 basis points on Wednesday in response to inflation that’s recently hit 7.7%, but instead opted for an even higher rate jump, its largest for nearly 25 years.

Read more: Bank of Canada announces huge rate hike

While it takes a long time for monetary policy to have an impact on the economy, Reitzes said there was little practical difference between a 75-point and 100-point hike, although it has allowed the Bank to move forward more quickly and “frontload” its path on rates.

“I don’t think 75 versus 100 makes all that much of a difference. But what it does do is enable them to get that much closer to their end point and, maybe from their perspective, it’s ‘Let’s get there as quickly as we can,’” he said.

“One hundred is the biggest move that we can reasonably go. If they want to get to 3.5%, maybe it’s another 100 basis points in September, and then they’re done.”

A second successive one-percentage-point hike at the next rate announcement isn’t BMO’s forecast, but it’s certainly a possibility, said Reitzes.

He pointed to the fact that the central bank is more than happy to move in 1% increments when cutting rates in emergency situations, meaning an increase of a similar size shouldn’t be completely out of the question.

Having introduced three consecutive so-called “oversized” rate jumps – two by a half point, and one by a full percentage point – the Bank has now normalized those types of hikes, he said, with the odds of a similar 100-basis-point move by the US Federal Reserve also increasing.

In mid-June, a BMO report indicated that “the relentless strength of inflation, and the policy response needed to address it” were increasing the risk of a hard landing and possible recession for the North American economy.

Reitzes said the central bank was still unlikely to shift its focus toward preventing a recession, and away from bringing inflation down, as long as levels remained high – even despite that elevated risk to the economy.

Read more: Bank of Canada: reaction to seismic rate hike

“It’s all about the direction and the level [of inflation] and, for now, the direction is higher, the level is way too high,” he said. “And so that is their one and only focus at this moment.”

In its announcement on Wednesday, the Bank said it expected inflation to start coming down this year, dropping to around 3% by the end of next year and hitting its 2% target by 2024’s year end.

Still, Reitzes said it would be “fortuitous” if inflation had hit its target by that stage. “That would be a decently good news story, barring a very deep recession that gets us there sooner,” he said.

Almost half of the 41 main components of consumer price index (CPI) inflation are rising at 6% higher, he explained, giving it a breadth and depth that is “problematic.”

Persistent and resilient inflation could mean the Bank will have to continue on its rising-rates trajectory – a development that could spell further trouble for Canada’s housing market, according to Reitzes.

“The more aggressive the Bank gets, and out of necessity perhaps because of inflation, the more you are going to see housing markets in Canada suffer,” he said.