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Bank of Canada surprises with smaller hike of 50 basis points to key rate

Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ontario, Canada April 13, 2022. REUTERS/Blair Gable
The Bank of Canada hiked its benchmark rate on Wednesday by 50 basis points. (REUTERS/Blair Gable)

The Bank of Canada hiked its benchmark rate by 50 basis points on Wednesday, a move that was smaller than expected and comes as the central bank downsized its growth projections for next year.

The increase marks the fifth consecutive outsized hike, bringing the rate to 3.75 per cent. Economists had widely expected the Bank of Canada to issue another big hike on Wednesday, although markets had priced in a larger 75-basis point increase.

While the hike marked a slight slowdown for the Bank of Canada, it isn't done yet. The central bank reiterated on Wednesday that further rate hikes will be needed, "given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy." The bank said in a statement that "future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding."

"This tightening phase will draw to a close. We are getting closer, but we are not there yet," Bank of Canada governor Tiff Macklem said in a press conference on Wednesday.

"Coming into this meeting, interest rates were already considerably higher. Combine that with the fact that there are now clear signs that the economy is slowing, we judge that it was appropriate to slow the pace of increase in our policy rates from very big steps to a big step."

The Bank of Canada has been on one of the most aggressive tightening cycles in its history as it tries to fight soaring inflation. The central bank has issued six consecutive rate hikes to bring its benchmark rate from 0.25 per cent in March to the current rate of 3.75 per cent.

Bank of Canada slashes growth forecasts

The bank acknowledged that economic growth will stall this year through the first half of 2023 as the effects of higher interest rates take hold.

In its Monetary Policy Report released Wednesday, the Bank revised its economic growth forecast, projecting that GDP in Canada will slow to 3.3 per cent this year (from a previous forecast of 3.5 per cent), and reach 0.9 per cent next year (down from a previous forecast of 1.8 per cent) and 2 per cent in 2024 (down from a previous forecast of 2.4 per cent).

The Bank forecast that GDP growth will slow to between zero and 0.25 per cent through the end of 2022 and the first half of 2023.

"This suggests that a couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth," the central bank said.

A technical recession is defined as two consecutive quarters of negative growth.

Macklem said that the close-to-zero growth is "not a severe contraction, but it is a significant slowing of the economy."

"With growth essentially zero for the next several quarters, that will give supply the opportunity to catch up with demand and that will relieve price pressures in our economy," he said at Wednesday's press conference.

"Unfortunately, there's no easy way of restoring price stability. We actually need a period of slower growth to let supply catch up and relieve those price pressures."

CIBC economists Andrew Grantham and Karyne Charbonneau wrote in a research note on Wednesday said the statement and downgraded growth forecasts "hint at an economy that is losing momentum maybe a little quicker than previously anticipated."

"While the Bank of Canada slightly under-delivered today in terms of the size of rate hike delivered, its downgraded view of potential growth and continued commitment that interest rates 'will' need to rise further doesn't suggest to us that the peak in interest rates will be any lower than we were expecting heading into today's announcement," the economists wrote. They expect the benchmark rate to reach a peak of 4.25 per cent.

While inflation may have peaked in June, it is still well above the Bank of Canada's target of around 2 per cent. Prices cooled slightly for the third month in a row in September, with the Consumer Price Index dropping to 6.9 per cent due largely to lower gas prices, but the cost of food continued to soar, increasing at the fastest rate in 41 years.

"In the Bank of Canada’s game of chicken with inflation, central bankers were the first to swerve," Desjardins economist Royce Mendes wrote in a note to clients shortly after the Bank's announcement.

"The fact that core inflation hasn’t slowed, inflation expectations remain elevated and demand is still outrunning supply, the Bank could have easily justified a larger rate hike. That said, the risk of such an aggressive move apparently outweighed the reward."

Consumers are already feeling the effects of the Bank of Canada's rapid rate hikes. A Yahoo/Maru Public Opinion released this month found that 57 per cent of Canadians are feeling the impacts of rising interest rates, with 18 per cent saying they are "worried sick" about the effects rate hikes could have on their families.

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

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