Bank of Canada Raises Policy Rate to 0.5%, Sees More Hikes Ahead

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Canada's central bank started what's expected to be a series of interest-rate hikes as it tries to wrestle inflation down from a three-decade high.

Policymakers led by Governor Tiff Macklem increased the benchmark overnight rate by a quarter percentage point to 0.5% at a decision Wednesday in Ottawa, in a widely expected move. Officials also said they expect to raise borrowing costs more because of elevated inflation pressures.

The rate move is the first increase in borrowing costs since 2018, and the start of what some are anticipating will be one of the fastest hiking cycles since the central bank adopted an inflation target three decades ago. Markets are betting the Bank of Canada's overnight policy rate will hit as high as 1% by June, and 1.75% by this time next year.

“As the economy continues to expand and inflation pressures remain elevated, the Governing Council expects interest rates will need to rise further,” officials said in the policy statement.

The Canadian dollar extended gains after the decision, up 0.7% on the day to C$1.2659 per U.S. dollar at 11:57 a.m. in Toronto. Yields on Canadian two-year bonds jumped 10 basis points to 1.436%.

Like other central banks, the Bank of Canada has become increasingly worried about the prospect of losing control of inflation as emergency levels of pandemic stimulus fuel demand in an economy that is already running up against capacity.

The most glaring example of that has been a boom in real estate as speculators and other buyers take advantage of the cheap borrowing costs to fuel price wars for homes.

The Bank of Canada has held its benchmark at the emergency level of 0.25% since March 2020. Banks use that benchmark to price borrowing costs for clients on variable-rate mortgages, and should announce higher rates on lending as early as Wednesday.

“Rates are going to go up. They're going to up materially and it's going to make a lot of people nervous,” Robert McLister, the mortgage editor at financial-services agreggator RatesDotCa, told BNN Bloomberg Television.

What Bloomberg Economics Says...
“Regarding quantitative tightening (QT), the statement signaled passive rolloff but gave no clear signal on timing. As it considers exiting the reinvestment phase, the BoC expects QT ‘would complement' rate increases. An announcement in April, with rolloff beginning in May, is our baseline scenario.”
-- Andrew Husby, economist
For the full analysis, click here

With the country facing the fastest inflation in a generation, policy makers on Wednesday warned price pressures are becoming more pervasive, and there are growing risks that expectations will begin to drift higher -- a strong indication the issue is top of mind.

“The Bank will use its monetary policy tools to return inflation to the 2% target and keep inflation expectations well-anchored,” officials said.

The Bank of Canada up until now has been downplaying worries that inflation expectations are moving away from 2%. But expected price gains are a key determinant of actual inflation because businesses increase prices and workers seek pay raises in part on what they anticipate costs will look like going forward.

Russia's invasion of Ukraine, meanwhile, only threatens to fuel inflation, the central bank said. “The situation remains fluid and we are following events closely,” policymakers said.

The growing inflationary risks also come at a time when recent economic data underscore how economic slack has been fully absorbed, officials said, adding that the nation's rebound from the latest wave of Covid-19 is “well in train.”

While there was some speculation the Bank of Canada would indicate on Wednesday an imminent start to shrinking its balance sheet, the central bank chose to continue its policy of keeping its government bond holdings constant for now.

The central bank has seen its holdings of federal government bonds rise by about C$350 billion ($275 billion) during the pandemic.

Policymakers gave no specific details on when they plans to start the balance-sheet unwind, but did say the bank will “be considering” when to start the process. Officials said the process -- known as quantitative tightening -- would “complement” increases in the policy rate.

Macklem will offer more insight into the bank's thinking in a speech and news conference on Thursday.