The Bank of Canada on Wednesday dialed back the pace of rate hikes, announcing a 50-basis-point hike and bringing the policy rate to 3.75%. This marks a 3.5% increase in just eight months, since the first rate hike in March.
This smaller-than-expected rate hike comes as recession fears increase, and the Bank of Canada predicts a recession in the first half of 2023.
Reasons for increasing interest rates are plentiful amid strong core inflation, high inflation expectations, a tight labor market and excess demand in the economy.
Despite a three-month consecutive decline largely due to falling gasoline prices, inflation is still running hot. September’s consumer price index report showed a mere 0.1% decline on the year-over-year headline number, and month-over-month prices went up 0.1%. Worse yet, measures of core inflation remain particularly stubborn.
A slowdown in the global economy has contributed to lower demand for exports. However, businesses nationwide are still dealing with widespread labour shortages and excessive consumer demand, especially in service sectors.
U.S. comparison
Wednesday’s announcement is a risky move for the Bank of Canada, marking a divergence from the Federal Reserve for the first time this year. As the Federal Reserve is widely anticipated to hike rates by 75 basis points next week, the smaller hike by the Bank could cause the Canadian dollar to slide in value relative to the U.S. dollar.
So far this year, the Canadian dollar has lost the least value compared to other currencies in relation to the U.S. dollar, and that is in part because the Bank’s path of interest rate hikes has been largely consistent with the Fed.
If the Canadian dollar loses value, it will cause imports from the United States to become more expensive for Canadian households and businesses, further fueling inflation.
The takeaway
It remains to be seen whether a smaller interest rate hike will end up easing recession fears or cause inflation to be more stubborn to bring down.
What is clear is that the rate-hiking cycle will continue, albeit at a slower pace. Expect more interest rate hikes to come in December through early 2023.
