The Bank of Canada is likely to raise rates again on Wednesday, but should it?
The Bank of Canada is expected to raise its benchmark interest rate by a quarter of a percentage point this week, which would bring it to 4.5 percent.
If that happens, it will be the eighth time in a row that the bank will choose to raise benchmark interest rates, making borrowing more expensive for consumers and businesses.
But for the first time in nearly a year, there is no solid consensus among those watching the central bank that another hike is on the horizon — or even whether it should.
The bank is engaged in a battle to subdue inflation and believes rate hikes are the best weapon at its disposal to win that war.
It is a war that has caused a lot of collateral damage, including on the housing market, where average prices have fallen by 20 percent since February. Other forms of consumer debt, such as credit cards, are also rising to record levels.
Yet rate hikes have so far only managed to bring inflation back from a 40-year high of more than eight percent last summer to 6.3 percent last month.
That is still twice as high as the upper limit of the bandwidth the bank would like to see, which is why a majority of economists think another increase is on the horizon. But Pablo Villanueva, an economist at Swiss Bank UBS, is among those who think that perhaps the best thing the Bank of Canada can do is do nothing at all.
“The data since December shows an economy that is weakening,” he said, noting that Canada’s GDP likely only grew by about one percent in the fourth quarter of 2022. That is significantly lower than the three percent average for the rest of the year. Wage gains and employment figures paint a similar picture.
A few of the bank’s own reports from earlier this month also sing from the same songbook, with a majority of consumers and businesses telling the central bank they now expect the economy to slide into recession this year.
Villaneuva says the recent data on Canada’s GDP and the recent spate of layoffs add up to a pretty compelling case for staying on the sidelines for a while.
“We think this weaker outlook for the economy and inflation should give the Bank of Canada confidence that it can postpone further hikes at least in the short term,” he said.
An important reason to hold on is that it usually takes six months to a year and a half before the full impact of interest rate hikes is felt.
“We recognize that we raised interest rates quickly and that the effects are spilling over into the economy,” Sharon Kozicki, deputy governor of the Bank of Canada, told a business crowd in Montreal last month.
“In other words, we’re going from how much to raise interest rates to whether or not to raise interest rates,” she said.
Karyne Charbonneau, an economist at CIBC, thinks the bank is likely to raise again on Wednesday, but she’s among those who think there’s unlikely to be another hike after that.
“If central banks are wise enough to recognize the delayed effects of what they’ve already done, they won’t have to deliver as many rate hikes,” she said.
The case for standing pat
While the headline inflation rate continues to rise at an eye-popping rate, beneath the surface it’s not hard to find goods and services that are actually cheaper now than they used to be.
Nearly two dozen of the roughly 300 subcategories that Statistics Canada tracks are now in negative territory for the year, including books, computer and digital equipment, children’s clothing and footwear.
Slightly cheaper drugs and parking fees may be cold comfort to anyone trying to fill a gas tank — or a grocery cart — lately. But as demand for goods and services declines, more and more items will move into that negative range, bringing overall inflation down with it.
So if the bank is looking for excuses to take a break, it’s not hard to find.
Stephen Gordon, an economics professor at l’Université Laval in Ste-Foy, Que., has been tracking short-term inflation trends online for more than a year now. He notes that annual inflation over the past three months is now below four percent. A year ago it was more than three times as much.
Investors, too, appear to be less confident than they have been all year as the bank is about to raise again. Trading investments known as swaps on Monday implies that the market thinks there is a three in four chance of an increase on Wednesday, but that means there is a one in four chance there is none.
That’s the first time that figure is anything less than certain since the bank began hiking last February, and a sign investors are betting with real dollars that the winds of monetary policy could soon blow in a different direction.
Regardless of what happens this week, Gordon says the real test of inflation will be in the February numbers, as that marks one year since Russia invaded Ukraine, kicking already-ongoing inflation into high gear.
“I see a reason to take a break,” he said in an interview with CBC News Monday. “But we’re still in wait and see mode on the data.”