The Bank of Canada announced on Wednesday that it would raise its overnight rate to 0.5%, 25 basis points from the lower bound policy rate of 0.25%, to tackle inflation.
This marks the first rate hike in more than three years. The bank, however, said it would keep its holdings of bonds on its balance sheet constant and continue its reinvestment phase.
This came as no surprise since the economy seems to be well on its way to recovering from the omicron variant’s surge. Consumer demand remains strong, and inflation is proving increasingly persistent.
With inflation at its highest rate in 30 years a rate hike is pertinent. While headline inflation has exceeded the 2% target for nearly a year, the recent uptick in core inflation is concerning as it suggests pervasive price increases that will be difficult to tame.
Adding to the central bank’s challenge is that the main causes of inflation, including supply chain disruptions and rising oil prices, are outside of the bank’s control.
The rate hike, though, can help anchor long-run inflation expectations, which have begun drifting from the 2% target. The bank’s actions can also play a role in cooling the overheated housing market, which has been breaking one record after another. As borrowing becomes expensive, households will think twice and hold off on buying.
The Bank of Canada acknowledged intensifying geopolitical risks that rule out a rate hike of more than 25 basis points at this point. The bank will be monitoring these risks closely when making rate decisions over the next few months.
The takeaway
While the market has pulled back from its hawkish stand of seven rate hikes this year, we maintain that four rate hikes are reasonable given conditions at home and abroad. As long as consumer confidence is solid and demand is robust to support economic growth, the bank will have room to raise rates further as well as reduce its balance sheet.
