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Bank of Canada hikes key rate by another 75 bps, warns more hikes ahead

Bank of Canada Governor Tiff Macklem speaks during a news conference in Ottawa, Ontario, Canada October 28, 2020. REUTERS/Blair Gable
The Bank of Canada hiked its benchmark interest rate by 75 basis points on Wednesday. (REUTERS/Blair Gable)

The Bank of Canada hiked its benchmark interest rate by 75 basis points on Wednesday, the fourth consecutive outsized hike, and the central bank warned further increases are to come.

The hike brings the key interest rate to 3.25 per cent, the highest level since April 2008, when the Bank was slashing its rate in the midst of the Great Recession. Canada now has the highest policy interest rate among G7 countries.

The central bank warned the policy rate will need to rise further "given the outlook for inflation."

"As the effects of tighter monetary policy work through the economy, we will be assessing how much higher interest rates need to go to return inflation to target," the Bank said in a statement released with the decision.

"The Governing Council remains resolute in its commitment to price stability and will continue to take action as required to achieve the 2 per cent inflation target."

Economists widely expected the Bank of Canada to issue its fourth consecutive outsized hike on Wednesday, with a majority of those surveyed by Bloomberg anticipating a 75 basis point increase.

Wednesday’s decision brings the benchmark rate into restrictive territory. The Bank of Canada has estimated that the neutral range for its interest rate, where it is not stimulative nor does it weigh on the economy, to be within two and three per cent.

The Bank of Canada has aggressively hiked interest rates since March as it attempts to set a firehose against scorching inflation. The central bank raised its benchmark rate by 100 basis points in July, the first full percentage point increase since 1998, a decision that came after two consecutive 50 basis point hikes. Before March, the interest rate sat at 0.25 per cent.

Canada’s inflation may have hit a peak, with the July’s Consumer Price Index (CPI) decelerating for the first time since last June, but it remains well above the central bank’s target of around 2 per cent.

The Bank of Canada said Wednesday that while GDP growth in the second quarter was "somewhat weaker" than it had originally forecast, domestic demand remains strong, with consumption growing by 9.5 per cent and business investment up by nearly 12 per cent. The central bank also noted that core measures of inflation (excluding gasoline) continue to increase, and that surveys suggest short-term inflation expectations remain high.

"The longer this continues, the greater the risk that elevated inflation becomes entrenched," the Bank said.

The warning that the policy rate will need to rise further sets the stage for another increase on October 26, economists say. CIBC World Markets chief economist Avery Shenfeld lifted the target for the end of the Bank of Canada's targeting cycle, "with at least another quarter point on tap for October."

"Even then, the Bank is likely to want to leave the door open to go beyond 3.5 per cent until it gets more definitive evidence of a deceleration in growth and inflation pressures," Shenfeld wrote in a note shortly after Wednesday's decision was released.

"We see that as likely to be in evidence over the next few quarters, but probably not fast enough to forestall at least a small further hike in October."

Alicja Siekierska is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @alicjawithaj.

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