For the first time in months, the possibility of another Bank of Canada interest-rate hike appears to be on the table this week.
The central bank has kept interest rates steady since January. However, a run of strong economic data over the past month has raised doubts about whether borrowing costs are high enough to bring inflation under control.
A growing number of analysts and investors are betting on at least one more quarter-point interest-rate increase this summer, which would lift the central-bank’s benchmark rate to 4.75 per cent. Many now expect a rate hike in July. However, the more hawkish among them think it could happen this Wednesday.
“The bank needs to show it’s serious,” said Stephen Brown, deputy chief North America economist at Capital Economics. “And I don’t think you show you’re serious by waiting another six weeks, just in case. You show you’re serious by acting as soon as possible.”
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Interest-rate swaps, which capture market expectations about monetary policy, are pricing in a 40-per-cent chance of a quarter-point increase at this week’s rate announcement, according to Refinitiv data. Market odds are around 65 per cent for a rate hike in July.
Bank of Canada Governor Tiff Macklem has given no indication of what will happen on June 7. But he has stressed in recent appearances that he’s prepared to restart the bank’s rate-hike campaign if there’s an “accumulation of evidence” that inflation and economic activity aren’t slowing as much as expected.
The central bank’s aggressive tightening – which involved eight consecutive rate increases between March, 2022 and January, 2023 – was designed to bring economic growth to a standstill to reduce upward pressure on consumer prices.
Inflation has come down significantly since last summer, falling to an annual rate of 4.4 per cent in April from a high of 8.1 per cent last June. But the Canadian economy, broadly speaking, is proving remarkably resilient to higher borrowing costs.
Consumers continue to spend eagerly and businesses keep hiring workers, holding the unemployment rate near a record low. Housing-market activity, which slumped last year, has picked up in recent months, fuelling an uptick in home prices. In short, the recession many economists were predicting last year hasn’t materialized – at least not yet.
“We are seeing some signs of fragility in Canada as well as the global economy, but they just haven’t added up to the kind of slowdown that the Bank of Canada was seeking,” said Avery Shenfeld, chief economist with Canadian Imperial Bank of Commerce.
Strong economic growth and low unemployment are usually a good thing. But right now, they’re a problem for Canada’s central bankers, who believe the economy needs to stall to bring demand and supply back in line. If that doesn’t happen, they argue, inflation could get stuck above the bank’s 2-per-cent target.
Mr. Shenfeld expects Mr. Macklem and his team to hold rates steady on Wednesday while they wait for more up-to-date labour-market data from Statistics Canada. But they will need to sound hawkish, potentially signalling a rate hike in July, Mr. Shenfeld said.
“If they don’t give the economy a speeding ticket, they’re certainly going to issue a warning that both growth and the labour market are too hot, and that we will face higher interest rates if that doesn’t start to change soon,” he said.
The Bank of Canada’s governing council considered raising rates in April, according to a published summary of the deliberations, but opted to wait for more data. Since then, those numbers have consistently surprised to the upside.
Employers added another 41,000 jobs in April, and average hourly wages grew at the brisk annual rate of 5.2 per cent. Real GDP growth exceeded Bay Street and Bank of Canada forecasts for the first quarter, and showed momentum heading into April, Statscan reported last week.
Recent inflation data also showed concerning signs of strength. The annual rate of consumer-price-index inflation ticked up to 4.4 per cent in April, from 4.3 per cent in March, and several closely watched “core” inflation metrics rose month over month.
Central-bank economists expect inflation to fall to around 3 per cent this summer, as prices for goods level off and year-over-year oil-price comparisons drag down headline inflation. But they remain nervous about continuing inflation for services, which they say is driven by labour-market tightness and wage growth.
“In our baseline forecast, the labour market will soften as the economy slows. Wage growth will ease. Businesses will revert to more normal price-setting behaviour. And near-term inflation expectations will come into line with the inflation target,” Mr. Macklem said in a speech last month.
“But there is a risk that these adjustments will take longer or stall, and inflation will get stuck materially above the 2-per-cent target.”
Another rate hike – if it happens – could have a chilling effect on the real estate market, which has rebounded in recent months as interest rates have stabilized, according to James Laird, co-chief executive officer of Ratehub.ca, and president of mortgage lender CanWise.
“Because a rate hike is now a possibility, fixed rates [on mortgages] have already increased. Variable-rate holders who thought that rate hikes were over will be holding their breath to see if their rates are going to go up even further,” Mr. Laird said in an e-mail.
“If the bank does choose to raise rates further, this will put downward pressure on home values and housing activity as spring turns to summer.”
