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Bank of Canada set to deliver even bigger interest rate hike on Wednesday

·4 min read
Bank of Canada Governor Tiff Macklem speaks during a news conference in Ottawa, Ontario, Canada December 15, 2021. REUTERS/Blair Gable
The Bank of Canada is widely expected to hike its benchmark interest rate by 75 basis points on Wednesday. (REUTERS/Blair Gable)

The Bank of Canada is widely expected to hike its benchmark interest rate by 75 basis points on Wednesday, as it continues on an aggressive path to try to rein in soaring inflation.

The outsized hike would be the largest increase since 1998 and would come after two consecutive 50 basis point hikes. A 75 basis point increase would bring the central bank's policy interest rate to 2.25 per cent for the first time since 2008.

Several economic indicators released since the Bank's last decision in June have reinforced the expectations of an outsized hike.

Inflation jumped 7.7 per cent in May, surpassing economist expectations and marking the biggest year-over-year increase since January 1983. With gas prices having surged last month, economists say inflation could hit the 8 per cent threshold in June.

A pair of Bank of Canada surveys also showed that businesses and consumers anticipate high inflation to persist for longer, raising concerns that inflation expectations are becoming entrenched. The central bank's quarterly business outlook survey found that companies' expectations for near-term inflation increased, while more firms expect inflation to be higher for longer. Consumer expectations for inflation are also on the rise, with short-term expectations hitting new record-high levels.

On top of that, employment data released by Statistics Canada on Friday showed the labour market remains tight, with the unemployment rate falling to a record low while wages increased.

"The recent acceleration in wage growth and rise in long-run inflation expectations leave little doubt that, despite the drop back in commodity prices, the Bank of Canada will follow through with a larger 75 basis point interest rate hike," Stephen Brown of Capital Economics wrote in a research note.

The Bank of Canada is one of many central banks around the world embarked on an aggressive path to tighten monetary policy in the wake of skyrocketing inflation. The bank has estimated that the neutral range, where the interest rate is no longer stimulative, is within two to three per cent.

The Federal Reserve hiked its benchmark rate by 75 basis points last month, a move that BMO Capital Markets chief economist Douglas Porter said was "paving the way for others to become more aggressive."

"We fully expect a 75 basis point rate hike," Porter wrote in a research note last week.

"In fact, there is a reasonable case to be made for a 100 basis point step – such a hike would take the overnight rate to 2.50 per cent, immediately moving to the middle of the Bank’s range for neutral rates. It could also be justified by the wild inflation overshoot."

However, Porter notes that a surprise 100 basis point hike is still unlikely, as the market has already priced in a 2.25 per cent rate and the Bank officials have said "they want to be a source of stability and predictability."

What it means for Canada's housing market

Still, a 75 basis point hike will likely put further pressure on the housing market and heavily indebted Canadians.

The Canadian housing market continued to cool in May amid rising interest rates, according to the Canadian Real Estate Association, with national home sales falling 8.6 per cent on a monthly basis. The number of transactions last month was 21.7 per cent below the record set in May 2021.

The Canada Mortgage and Housing Corporation (CMHC) said in a research note released Monday that in a high interest rate scenario – where the Bank of Canada hikes interest rates to 3.5 per cent by early 2023 before gradually returning to its neutral rate of 2.5 per cent – national average house prices remain elevated but decline by 5 per cent by mid-2023. The moderate interest rate scenario – where the benchmark rate hits 2.5 per cent by early 2023 and remains at that level until 2025 – would see a house price decline of 3 per cent, CMHC said.

"The housing market is flashing deeper signs of strain, with sales falling fast, and prices poised to follow in many regions," Porter wrote.

"But those rising risks simply cannot and will not sway the Bank from soldiering on; the risk of recession has to be a secondary consideration to the reality of red-hot inflation."

With files from Bloomberg News

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

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