Interest Rates Rise This Week: What You Need to Know About the Bank of Canada’s Decision

The Bank of Canada will raise interest rates at the end of its final round of policy deliberations on Dec. 7. Governor Tiff Macklem guaranteed it.

“This phase of tightening is coming to an end,” he told the House Finance Committee Nov. 23. “We’re getting closer, but we’re not there yet.”

Macklem didn’t reveal everything. No one knows if he’s leaning towards another outsized hike, as he’s endorsed in the previous five interest rate decisions, or if he’s inclined to start slowing down more gently and returning to the preferred pace. of the central bank by a quarter of a point. changes.

The lack of guidance has led to an intense debate on Bay Street and Wall Street, where forecasters are split on whether Macklem, after hearing from his deputies on the Board of Governors, will opt to raise the benchmark rate of quarter of a percentage point (base 25 points) or half a percentage point (50 basis points). The answer comes at 10 a.m. Ottawa time on December 7. Until then, here’s what you need to know:

The backstory

The consumer price index has risen at an annual rate of more than 3% – the top of the Bank of Canada’s comfort zone – since April 2021, peaking at a dangerously rapid rate of 8.1% in June .

Macklem and his colleagues were taken by surprise. They believed that the explosion of inflation in 2021 was mainly linked to supply backlogs that accumulated during the pandemic; they bet price pressures would recede as soon as things returned to normal. It never happened. Meanwhile, the easing of health restrictions triggered a wave of pent-up demand from households who had been forced to save for nearly two years.

The Bank of Canada has been playing catch-up all year. Macklem started with a tentative one-quarter increase in March, followed by “jumbo” increases of half a point in April and June, a full percentage point in July, three-quarters of a point in September and half a point in October, bringing the benchmark rate to 3.75% after starting the year at 0.25%.

The story continues

It was a shocking change in direction after more than a decade of ultra-low interest rates, as the target is now at its highest level since 2008. Inflation appears to be slowing, but was still hovering around 7 % in September and October. : too high for policymakers responsible for keeping annual increases in the consumer price index around 2%.

“The economy is still in excess demand,” Macklem told the finance committee. “It’s overheated.”

The case for 25

Some economists worry that the Bank of Canada, along with the US Federal Reserve and all the other central banks that are raising borrowing costs just as aggressively, are about to send the economy into a tailspin. “We have conditions that are close to recessionary conditions internally,” Sébastien Mc Mahon, economist at Quebec-based Industrial Alliance, Insurance and Financial Services Inc., said in a video to his clients, citing Statistics Canada’s third quarter gross sales count. domestic product, which showed that household consumption contracted in the July-September period for the first time since the second quarter of 2021.

There is cause for concern about the impact of the sharp swing in borrowing costs on consumer psychology, given that central banks have kept interest rates near zero for so long. Indeed, Statistics Canada observed an increase in the household savings rate, which could signal a decline. That’s troubling because the Great Recession was as bad as it was because U.S. households, struggling with high levels of debt, pulled out (or declared bankruptcy) when financial conditions are tightened. Canadian households are as indebted today as their American cousins ​​were then. Research from the Bank of Canada shows that half of variable rate mortgages have reached levels where payments only cover interest, a potential anchor on consumer demand.

Housing investment, which surged when the Bank of Canada lowered interest rates to fight the COVID-related recession, has now fallen in consecutive quarters. Housing has been the main driver of the economy since at least 2010. Business investment and exports will need to pick up the slack, which may be too much to ask with the US and Europe also on the brink of recession.

For some economists, weakening demand and falling house prices prove that the central bank’s attack on inflation is working, because domestic demand is the only source of price pressures on which policy makers have the least control. Doing more to stifle domestic demand when the main cause of inflation remains commodity prices and supply problems would be overkill, according to Royce Mendes, head of macro strategy at the Fédération des caisses Desjardins du Québec, who predicts that Macklem will raise the benchmark rate to four percent, then stop to assess.

“The economy just can’t take much more of this,” Mendes said in a note.

The case for 50

Charles St-Arnaud, a former Bank of Canada economist who now heads research at Alberta Central, read the GDP report Nov. 29 and revived his bet that Macklem would cut his interest rate hikes to a quarter. point next week. Three days later, after absorbing Statistics Canada’s latest labor force survey, he changed his mind and informed his clients that the Bank of Canada would raise the cost of borrowing by half a point on December 7. .

Statistics Canada’s household survey found that employers added about 10,000 jobs in November after adding more than 100,000 jobs the previous month; the unemployment rate fell to 5.1%, a figure that suggests anyone who wants a job could get one; and that year-over-year increases in the average hourly wage are rising more than 5% for the sixth month in a row, suggesting that workers are now demanding wage increases that compensate for inflation.

“The Bank of Canada needs to slow growth and create excess capacity in the economy to fight inflation,” St-Arnaud said in a note. “This will likely lead to an increase in the unemployment rate and job losses. From this perspective, a weaker labor market would be a welcome outcome for the Bank of Canada.

The pace of wage increases will concern Macklem, not because he is waging a ‘class war’, as the head of Canada’s largest private sector union said last month, but because expectations are key. how central bankers view inflation. If workers and suppliers think prices will be 7% higher next year, they will demand compensation commensurate with a higher cost of living. Macklem wants to crush such thoughts before they take root. That’s why he raised interest rates so aggressively. He must convince that public inflation has come down to 2%, otherwise his job will be all the more difficult.

While Canada’s latest GDP figures showed that higher borrowing costs are starting to take hold, they also showed that the economy continued to grow at an annual rate of 2.9%, which is considerably faster than the Bank of Canada’s latest forecast. The economy appears to have plenty of momentum, and Macklem has made it clear that he is more concerned about inflation spiraling out of control than a mild recession. In fact, the central bank’s latest forecast predicts that growth will essentially stagnate in the final months of 2022, suggesting that the central bank is prepared to endure short-term difficulties to bring inflation back to its target.

“Virtually all of the data released since the October BoC meeting … pointed to generally stronger demand than the BoC likely assumed,” Veronica Clark, an economist at Citigroup Global Markets Inc., said in a note. “It would send the wrong message, and would generally be a weird time, to further slow the pace of the increases to 25 (basis points).”

Clark predicts Macklem will follow a half-point increase this week with quarter-point increases in January and March, then stop at 4.75%.

Meeting preparation

Here are some Financial Post backgrounders to help you prepare for the announcement:

Kevin Carmichael: Jobs numbers show Bank of Canada didn’t destroy economy after all

Watch: Economist Brett House explains why the Bank of Canada could hike half a point

Profits in 15 sectors, including oil and gas, driving most inflation: report

Fed’s Powell signals pullback in size of next interest rate hike, but with more hikes to come

Kevin Carmichael: The economy is growing faster than expected, increasing the chances of another big rate hike

Peter Hall: Why inflation isn’t really the problem

Banks seek workarounds to avoid mortgage default for struggling variable rate borrowers

• Email: kcarmichael@postmedia.com | Twitter: carmichaelkevin