Why the Bank of Canada rate hike won't be one and done

  6/9/2023 |   SHARE
Posted in Canadian Economy and Interest Rates by Crescendo Realty| Back to Main Blog Page

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More pain is on the way for indebted Canadian households, but they might be able to take some cold comfort that interest rates could soon peak, according to Bay Street economists.

"[The Bank of Canada] did tell us that it basically lost confidence that the current level of interest rates was enough to get inflation back to 2%. It's hard to see how a single 25 basis point hike would change that view. So I think most people now, certainly our forecast, is that the bank will hike again in July," Stephen Brown, deputy chief North America economist at Capital Economics, said in a phone interview.

He sees the Bank's benchmark rate topping out at five per cent as more data roll in through the summer about how businesses and consumers are handling higher rates.

BMO Capital Markets Canadian rates and macro strategist Ben Reitzes also expects the central bank will not increase rates beyond the five per cent threshold.

"We're getting to a point where rates are already quite challenging for a number of households. And then you're just going to put increasing amounts of stress on them and it does take a good amount of time for the full impact of these rate hikes to pass through," Reitzes said.

The Bank of Canada is back in hiking mode after lifting its benchmark rate by a quarter point on Wednesday to 4.75 per cent, with financial markets betting on another increase at the July meeting.

"We got the quarterly GDP numbers a week ago, and the Bank of Canada does put a lot of weight on those numbers," Reitzes said. "If the growth backdrop doesn't cool, it's hard for them to see inflation slowing."

Hindsight is 20/20

When the Bank first paused its rate-hiking cycle in March, economic data showed it was an appropriate move at the time, Brown says, as inflation was easing and home prices were falling.

What took most by surprise, he adds, is how quickly the economy rebounded.

Recent data releases showed the Canadian economy grew more than expected in the first quarter and inflation ticked higher. The labour market had also proved to be resilient, however, that eight-month streak of employment gains was halted in May as employers shed jobs, Statistics Canada reported on Friday.

"The data since April have tipped the balance. The accumulation of evidence across a range of economic indicators suggests that excess demand in the Canadian economy is more persistent than we thought, and this increases the risk that the decline in inflation could stall," Paul Beaudry, deputy governor of the Bank of Canada, said in a speech in B.C. on Thursday.

It's "really easy" to criticize the central bank's moves in hindsight, Reitzes says.

Both economists agree that the Bank's communications around the rate pause could have been refined.

"Maybe they didn't have to explicitly say they were on conditional pause and they could have left the door open a bit more. I think from a housing market perspective, maybe that would have been preferable because people wouldn't have maybe been as willing to jump back into the market. But other than that, I think it's really hard to criticize them," Reitzes said.

What about that recession?

With the strong start to the year, many economists have pushed out their calls for a recession.

But Brown says that might be exactly what’s needed to bring inflation back down.

“Recent events suggest it's a growing probability that we might need a recession to get inflation back to 2%. But that's not our base case at the moment,” he said, adding that even the psychological element of a shallow recession could drive consumers to rein in spending and therefore lower inflation.

He’s still forecasting rate cuts in early 2024 but says they could be delivered much slower this time around compared to previous rate-cutting cycles.

Meanwhile, Reitzes says a recession is likely still on the way in the second half of the year, though it’s not a “super high conviction call.”

“I would still call our recession scenario a pretty soft landing, but at some point, rates are going to bite and maybe it's just going to take a little bit longer than expected. And whether that's the second half of this year, or we go through the turn of the year, not quite certain, but at some point you have to expect that rates are going to bite.”

Source: Yahoo Finance

Bank of Canada, Bank of Canada Benchmark Rate