The Bank of Canada is raising its target for the overnight rate by half a percentage point to 1 per cent.
Canada's central bank says it will also stop buying government bonds and begin quantitative tightening (QT), beginning April 25.
The Bank of Canada also sharply increased its inflation expectations, saying Russia’s invasion of Ukraine is creating economic uncertainty.
“Price spikes in oil, natural gas and other commodities are adding to inflation around the world,” said the Bank of Canada in a release.
“Supply disruptions resulting from the war are also exacerbating ongoing supply constraints and weighing on activity. These factors are the primary drivers of a substantial upward revision to the Bank’s outlook for inflation in Canada.”
The Bank of Canada expects inflation to average almost 6 per cent in the first half of 2022 and above the control range throughout this year. It expects inflation to come down to 2.5 per cent in the second half of 2023 and return to its 2 per cent target in 2024.
It warns that further rate hikes are coming but says it isn't on autopilot to a pre-established rate.
“With the economy moving into excess demand and inflation persisting well above target, the Governing Council judges that interest rates will need to rise further.”
Bank of Canada Governor Tiff Macklem was asked why the rate was raised by 50 basis points instead of 25 basis points.
"With inflation well above target, with the economy moving in excess demand, there is a need to normalize monetary policy reasonably quickly and that is reflected in the decision today to raise the policy rate by 50 basis points," said Macklem during a news conference.
The 50bps increase was widely expected by economists, but is the largest single hike in more than two decades.
“The Bank of Canada brought out the big guns in its fight against inflation, but for those fearing the worst, it’s noteworthy that it still sees room for the economy to put in two reasonably healthy years for growth as it does that," said CIBC chief economist Avery Shenfeld.
The Bank of Canada forecasts Canada’s economy will grow by 4.2 per cent this year before slowing to 3.1 per cent in 2023.
Mortgage rates after rate hike
Variable rate mortgage holders can expect higher rates in the coming days, as lenders raise their prime rates.
LowestRates.ca used its mortgage calculator to crunch the numbers.
It says for an average priced Canadian home of $860,000 (with 15 per cent down amortized over 25 years), monthly mortgage payments based on a typical best five-year variable rate today of two per cent would be about $3,197.
The same mortgage with a 50 basis point rate rise means the estimated payment rises to $3,383, an increase of $186 per month or $2,232 per year.
"Some variable rate holders may think about switching to a fixed rate to bring some stability to their outlook, but anyone with variable rate will still be saving money over a fixed rate right now," said Leah Zlatkin, licensed mortgage broker. "Your best approach is to budget for more increases and talk to your broker about your options.”
After helping to boost the economy through the pandemic, the Bank of Canada now sees housing being an economic drag in 2022 and 2023.
Jessy Bains is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jessysbains.