Opinion | Have Interest Rates Peaked at 4.5 Percent?

After eight consecutive increases, the Bank of Canada paused this month and held its key rate unchanged at 4.5 percent, its highest level since July 2007. But is this just a temporary break, or will the bank increase the rates next month? Here are three reasons why I believe the rates might increase yet again:

Reason 1: Downward Pressure on the Loonie

The Canadian dollar has depreciated about three percent concerning the U.S. dollar since early February and a bit less concerning the euro and the British pound. If the Bank of Canada keeps its policy rates unchanged while other central banks may continue to raise theirs, it will further exert downward pressure on the loonie’s value. This, in turn, will fuel inflation by raising the price of most imported goods. Hence, to prevent the acceleration of inflation, the bank might increase the policy rate by 25 basis points next month.

Reason 2: Inflationary Pressure on Certain Goods

While year-over-year inflation was 6.3 percent in December, the data shows that prices increased rapidly until June and not so much afterward. Food, shelter, and gasoline accounted for 75% of the price hike. In particular, gasoline prices increased 48 percent in the first half of 2022, accounting for 40 percent of the overall inflation. The situation was quite different in the second half of the year as the price index remained almost unchanged due to price increases in food and shelter being offset by a 30 percent decrease in the price of gasoline. However, it seems unreasonable to expect that inflation will continue to decline due to a significant decrease in gasoline prices or any other component of the CPI basket. Hence, most likely, headline inflation will continue its descending path as a result of a process of disinflation, leading to the bank increasing the policy rate next month.

Reason 3: Bank of Canada’s Credibility at Stake

Although the situation remains fluid, I believe the Bank of Canada’s credibility is at stake. This month’s pause made the bank the first major central bank to halt interest rate hikes. This puts the bank on a different trajectory than the U.S. Federal Reserve and other central banks, which are still increasing their rates. Pushing the rates up will help the bank maintain its credibility and avoid putting itself and the economy in a dangerous situation.

Related Facts

• Bank of Canada’s rate hike history:
  • July 2017: 0.50%
  • September 6, 2017: 0.75%
  • January 17, 2018: 1.25%
  • July 11, 2018: 1.50%
  • October 24, 2018: 1.75%
  • January 9, 2019: 2.25%
  • July 10, 2019: 2.5%
  • October 30, 2019: 1.75%
  • December 4, 2019: 1.75%
  • January 22, 2020: 1.75%
  • March 13, 2020: 0.75%
  • March 27, 2020: 0.25%
  • April 15, 2020: 0.25%
  • March 10, 2021: 0.25%
  • April 21, 2021: 0.25%
  • June 9, 2021: 0.25%
  • July 14, 2021: 0.50%
  • October 27, 2021: 1.00%
  • December 8, 2021: 1.25%
  • January 26, 2022: 1.50%
  • March 9, 2022: 1.75%

Key Takeaway

The Bank of Canada paused its key rate hike, but there is still a possibility of further hikes in the coming months. However, with a decline in year-over-year inflation, the bank may not appear ready to commit to ending the tightening cycle but will likely increase the policy rate by 25 basis points next month. This decision will maintain the bank’s credibility while avoiding inflationary pressure through disinflation.

Conclusion

The Bank of Canada’s decision to pause interest rate hikes was consistent with market expectations, but it doesn’t appear to be the final decision. The Canadian economy has shown great resilience, and labor markets remain tight, but financial stability concerns have raised the possibility of further rate hikes. Moreover, with the pressure of global central banks raising interest rates, the Bank of Canada will likely increase its policy rate next month to prevent inflationary pressure and protect its credibility.