This morning, the Bank of Canada hiked interest rates by a full percentage point, the most since August 1998, when it tried to protect the CAD dollar in the face of the Asian financial crisis. This came as a surprise to the majority of market participants who were expecting an increase of 75 basis points. The Bank’s efforts are fully focused on preventing the nations four-decade-high inflation from becoming rooted and curbing excess demand. Today’s move has been cited as “front loading” and policy makers believe by doing so, they will limit the economic damage in the long run. Now, we sit at 2.5%, technically bringing us to neutral range, meaning that the cost to borrow is neither constrictive nor stimulative. It is clear that rates will have to exceed neutral range in order to combat runaway inflation, but for how long can depend on a number of factors.

 

 

We think one important consideration is the fact that many of these inflation metrics are lagging indicators, which means we get the data after the fact. The bank’s aggressiveness will hopefully help to reduce the reactionary nature which we’ve witnessed since the start of the year – remember when we thought inflation would be “transitory”.

 

Taking a look at the growth outlook for the Canadian economy, policy makers reduced gross domestic product expansion to 3.5% this year and 1.8% in 2023, down from 4.2% to 3.2% respectively. That view may turn out to be very optimistic, especially as Canada’s housing market is already cracking. There will also likely be a negative spillover effect from today’s announcement on consumer confidence, especially for those living on the margin and using revolving credit sources to supplement income. Remember that in 1998, after the Bank hiked by a full percentage point, it did an about face just over a month later and started to cut rates. The peak rate then was 5.75% versus today’s rate of 2.5%. The level of household and not for profit debt to disposable income is 181% today, compared to 109% back in 1998. Let’s hope the Bank is factoring this into its decisions.   

 

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These are the personal opinions of Andrew Pyle and the Pyle Group and may not necessarily reflect those of CIBC World Markets Inc.