Canada’s central bank shocked analysts this week by increasing the interest rate by 100 basis points. This has taken the base interest rate to 2.5% and will cause substantial financial worries for many struggling households with variable-rate mortgages. Policymakers have said that the aggressive step was necessary to try and control soaring inflation.
The increase is the biggest Canada has seen in more than 20 years and came as a shock to many, with analysts having predicted an increase of 0.75 basis points. Figures also show that inflation stood at 7.7% in the year to May, nearly four times the 2% target rate. Inflation is now at the highest level since 1983.
The move comes after it was revealed that inflation in the United States increased to 9.1% in the year to June. Many believe the US Federal Reserve will increase the base rate by 0.75% later this month.
Inflation more persistent than expected
Following the rate increase, Canada’s central bank said that inflation was higher and more persistent than it had forecast in its monetary policy report in April. In addition, the Bank noted that it was likely to remain at 8% in the coming months. The Governor of the Bank of Canada, Tiff Macklem, spoke at a conference recently. He said, “Front-loaded tightening cycles tend to be followed by softer landings. We are acutely aware that higher interest rates will affect Canadians who are already feeling the pain of high inflation but by increasing the cost of borrowing, we will moderate spending and return inflation to its target.”
The governor went on to say that the aim of the central bank is to put an end to soaring inflation without sparking a recession. However, he added that this had become a narrow path because of rapid price growth beyond their expectations.
The central bank further stated, “Consumers and businesses are expecting inflation to be higher for longer, raising the risk that elevated inflation becomes entrenched in price and wage-setting. If that occurs, the economic cost of restoring price stability will be higher.”
Canadian bank RBC has already predicted a recession across Canada next year. While this has not been forecast by the Bank of Canada, the central bank expects GDP growth to slow to 1.8% in 2023.
According to Macklem, many commodities exported in Canada are still at high price levels. He said that this could help to buffer the global slowdown in growth.
The latest rate increase is one of a series of hikes that have taken place over recent months as the central bank tries to tackle rocketing inflation. There was a 25 basis point increase in March, then 50 basis point increases in April and June. This has resulted in a cooler property market due to higher mortgage rates.