The Bank of Canada has embarked on a series of supersized rate hikes this year in a bid to tame inflation, but its upcoming policy rate decision on Sept. 7 comes as the economic picture has started to shift: inflation dipped below the eight per cent mark to an annualized pace of 7.6 per cent in July, while the country’s economic growth lost its momentum in the second quarter. Given these developments, here are some of the key questions on the minds of economists and market analysts ahead of this week’s decision.
How high will the bank go?
The broad consensus among economists is that the Bank of Canada will deliver another supersized rate hike at 75 basis points, bringing the policy rate up to 3.25 per cent and keeping its aggressive path of rate hikes going.
Reacting to the July inflation reading, most economists agreed that the Bank would not hike by less than 50 basis points. While some outright dismissed the idea of another 100-basis point hike at the time, others, such as National Bank’s Taylor Schleich, haven’t ruled out a rate hike of this size, putting the chance of a full-percentage-point hike at 20 per cent, more than the 10 per cent chance of a half-point hike.
What’s the impact if they do go beyond the neutral range?
A 75 or 100 basis point hike would have the policy rate break past the Bank’s theoretical neutral range of two to three per cent, the interest-rate range that would neither stoke or hinder economic growth. Pushing beyond the neutral range comes with risks for the Canadian economy, which is more sensitive to higher interest rate increases that other G7 countries due to higher, real-estate-fuelled household debt.
“As a result, the Canadian economy’s outperformance in the first half might be fleeting,” wrote Royce Mendes, managing director and head of macro strategy at Desjardins, in a Sept. 2 note. “Growth only held up because services spending was rebounding from lockdowns early in the year and businesses were rebuilding inventories after the worst of the supply-chain disruptions. In other words, the growth we’ve seen in 2022 is not sustainable.”
Mendes called breaking above the three per cent mark the moment where “rubber meets the road”, but added that the often-referenced neutral range no longer has relevance today since the economy faces numerous tailwinds and headwinds and inflation stands high above the two per cent target. Mendes also noted that the Bank of Canada’s statement would leave the door open to further rate hikes, but the central bank will have to drop the “soft landing” narrative as recession risks rise.
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Will this be the last supersized hike?
During his speech at the Jackson Hole symposium in late August, US Federal Reserve chairman Jerome Powell hawkishly suggested central bankers were ready to trade off economic growth for a pull-back in inflation. Bank of Canada governor Tiff Macklem also sounded hawkish notes in an August column for National Post, in which he wrote that even though higher interest rates had helped bring inflation down to 7.6 per cent from 8.1 per cent, his work in taming inflation was not done yet.
Pursuing lower inflation with the same tenacity as the US would spell out more pain for Canada’s housing-heavy gross domestic product, though economists noted that anything less than a 75 basis point hike this week would be seen as dovish and expect furthers following September’s decision .
However, economists such as Ian Pollick, the Canadian Imperial Bank of Commerce’s managing director and head of fixed income, have argued that a “narrative shift” could be at hand, with the central bank pausing its aggressive rate hike cycle after hiking by 75 points in September and taking a more data-dependent approach in the months ahead.