It’s Bank of Canada week again, and as Governor Tiff Macklem and his team prepare for Wednesday’s decision, signals have been piling up that Canadians will be looking at a 75 basis point hike this week, the largest single increase since the 1990s . In its policy statement last month, when the Bank raised rates by 50 basis points (bps) for the second time, it said it was “ready to act more aggressively if necessary to meet its commitment to achieve the 2% inflation target.” Evidence since then suggests “there’s a good chance it will follow that cue,” writes Stephen Brown of Capital Economics. Inflation was higher than expected in May at 7.7%, a 39-year high. Capital goods inflation rose to 8.3% in June, with an average of 7.6% in the second quarter, well above the 5.8% the Bank had forecast in April. Wages are also on the rise, up 5.2% from June last year, according to data on Friday. And worryingly for the Bank of Canada, Canadians’ inflation expectations have also risen. The Bank’s quarterly surveys revealed that more than half of businesses expect inflation to remain “substantially” above 2% for at least three years, and consumers expect inflation to remain at 4% five years from now. Commodity prices have dipped recently, with WTI down more than 2% this morning. Copper and iron ore prices have fallen by 20% in the past month, and wheat prices are almost back to where they were before the Ukraine war. But Capital reckons these price moves reflect central bank hawkishness and if policymakers exit now commodities will recover quickly. Unless oil prices fall quickly, Capital expects the Bank of Canada to hike by 75 bps on Wednesday and another 50 bps in September. A 25 bps hike in October would bring the rate to 3% which is slightly less than the 3.25% ceiling expected by the market. “Even if the Bank were to wind down a little earlier than we expected, this would still be one of the most intense policy-tightening cycles in decades,” Brown wrote. Canadians are already feeling that sting. Nearly 60% of Canadians surveyed for the MNP consumer debt index this morning said they are already feeling the effects of interest rate hikes, a number that is up significantly from last quarter. About a quarter of Canadians surveyed in the accounting firm’s quarterly survey said they are not financially prepared to face a one-percentage-point increase in interest rates. More than half (58%) said they were worried about the impact of rising interest rates on their financial situation, and 55% said they were worried about their ability to cover expenses next year without going into further debt. Currently, most five-year fixed mortgage rates range from 4.79% to 5.24%, with variable rates from 2.70% to 3.30%, according to RATESDOTCA. If the Bank of Canada raises the overnight rate by 75 bps to 2.25%, prime rates are expected to rise to 4.45%, putting variable rates at 3.45% and above, LowestRates.ca said. A homeowner with a 2.7% variable rate on a $700,000 home who has a monthly payment of $2,801 now would see that payment increase to $3,038, an increase of $237 per month, according to the LowestRates.ca calculator. “What’s important to understand is that interest rates are cyclical. At some point in the next few years, we will see them come back,” said RATESDOTCA mortgage expert Sung Lee. James Laird, co-CEO of Ratehub.ca, says the bond market is signaling that Canadians may get a reprieve after Wednesday’s projected 75bps hike. “Bond yields are down 60 basis points from their peak in mid-June. “The easing of bond yields should give consumers some comfort that the end of rate hikes can happen within the next couple of announcements,” Laird said last week. Capital Economics also sees a time when the Bank starts cutting interest rates, but not for at least a year, even if there is an economic downturn. “It will take some time for the labor market to weaken enough to dampen wage growth, and the Bank will have little appetite to start pumping fuel back into the housing market,” Brown wrote. “Our assumption for now is therefore that the Bank will only start easing policy at the end of 2023, cutting rates back to 2.5%.
