Bank of Canada raises key interest rate by half of a percentage

The Bank of Canada hiked its key interest rate by half of a percentage point on Oct. 26 and said rates will need to rise further to clamp down on decades-high inflation.

Since March, the central bank has raised its key interest rate six consecutive times, bringing it from 0.25 per cent to 3.75 per cent in one of the fastest monetary policy tightening cycles in its history.

Speaking at a news conference on Oct. 26, Bank of Canada governor Tiff Macklem said the bank expects its policy rate will need to rise further.

“How much further will depend on how monetary policy is working to slow demand, how supply challenges are resolving and how inflation and inflation expectations are responding to this tightening cycle,” Macklem said.

He said there are no easy outs in restoring price stability.

“We need the economy to slow down to rebalance demand and supply and relieve price pressures,” Macklem said.

“We expect growth will stall in the next few quarters — in other words, growth will be close to zero. But once we get through this slowdown, growth will pick up, our economy will grow solidly, and the benefits of low and predictable inflation will be restored.”

Economists were split on whether the Bank of Canada would go with half or three-quarters of a percentage point heading into the announcement on Oct. 26.

Tu Nguyen, an economist with RSM Canada, said the announcement is “surprising” and “risky” given the U.S. Federal Reserve is expected to raise rates by three-quarters of a percentage point next week.

“That could be risky in the sense that it could weaken the Canadian dollar even more than it is right now,” Nguyen said. “That could fuel inflation even further, because it makes anything that is imported from the U.S. to Canada more expensive.”

In its latest monetary policy report, the bank notes that although inflation in Canada has eased in recent months, prices for food and services continue to rise rapidly.

Canada’s annual inflation rate dropped slightly in September to 6.9 per cent but the cost of groceries continues to climb. According to Statistics Canada, the cost of groceries has been rising at the fastest pace since 1981, with prices up 11.4 per cent in September compared with a year ago.

The Bank of Canada says it expects inflation to slow to three per cent by the end of 2023 before getting back to its two per cent target by the end of 2024.

The Bank of Canada said the Canadian economy continues to operate with significant excess demand while businesses face widespread labour shortages.

Higher interest rates are starting to help rebalance supply and demand in the economy as higher borrowing costs slow spending, the bank said.