Ottawa June 8 2022: Canada’s central bank has signaled plans to race ahead with a series of oversized hikes to curb inflation, upping the risk of plunging the economy into a recession, say economists, though worth it if it keeps rapid price rises from becoming entrenched.
The Bank of Canada last week raised its policy interest rate to 1.5% from 1.0%, its second consecutive 50-basis-point hike, and said it was ready to act “more forcefully” if needed to fend off “galloping inflation,” already at a 31-year high.
That could mean more moves before pausing, larger than 50-bp increases or an end rate somewhere above neutral – the 2%-3% range where interest rates neither stimulate nor weigh on growth, Deputy Governor Paul Beaudry said.
A strong, front-loaded assault from the Bank of Canada will slow domestic demand and should help keep rising inflation from turning into a price spiral, economists said.
But it is a delicate balance and any slip could seriously hobble the economy just as key service sectors, like travel, are rebounding. In a worst-case scenario, Canada could be plunged into a recession, they added.
Canada’s flat yield curve is an indication that investors are betting on an economic slowdown, with the gap between 2- and 10-year bond yields at 14 basis points on Wednesday, the narrowest spread among Group of Seven countries.
The housing market, a key driver of Canada’s economy, has cooled sharply from February’s peak, as rate hikes cut into buying power. And the country’s export volumes are down 4.9% so far this year, a decline to date masked by hot commodity prices.
Still, inflation is running at 6.8% and set to rise further, Canada’s jobless rate is at a record low and businesses report more demand than they have the capacity to meet, bolstering the case for a forceful response.
Money markets are betting the Bank of Canada will raise its policy rate to 3.25% by the end of this year, the highest level since 2008 and three full percentage points above January’s 0.25%. Interest rate peaked at 1.75% in the 2017/18 tightening cycle.
That rapid pace could shock Canada’s economy, which has the highest level of household debt in the G7. Homes sales plunged 12.6% in April from March, with the full price impact of rapidly cooling demand still to come. But the Bank may be willing to risk a hard landing if it keeps consumer expectations in hand, economists said.
“The Bank of Canada’s recent communications suggest that it will be unfazed by the second consecutive double-digit drop in home sales in May,” said Stephen Brown, senior Canada economist at Capital Economics.
“This … leaves us concerned that it will take a more aggressive approach to policy tightening than is ultimately required, driving house prices sharply lower and risking a major recession.”
When asked directly if the bank would be willing to engineer a recession, Beaudry told reporters it would ultimately do what was needed.
“The bottom line is we will get inflation back to 2%. We’ll do what’s necessary to get there,” he said.
