Bank of Canada increases its benchmark interest rate

Today, in its second scheduled policy decision of 2022, the Bank of Canada made good on its pledge to increase interest rates in the face of higher inflation.

For the first time since the pandemic began to hurt the economy in March 2020, the Bank raised its overnight benchmark rate to 0.50% from 0.25%. As a result, the Bank Rate increases to 0.75% from 0.5% and the knock-on effect is that borrowing costs for Canadians will rise modestly although by historical norms, remain low.

The BoC also announced it is continuing its reinvestment phase, keeping its overall holdings of Government of Canada bonds on its balance sheet “roughly constant” until such time as it becomes “appropriate” to allow the size of its balance sheet to decline.

In its updated comments on the state of the economy, the Bank and singled out the unprovoked invasion of Ukraine by Russia as a “major new source of uncertainty” that will add to inflation “around the world,” and have negative impacts on confidence that could weigh on global growth.

These are the other highlights.

Canadian economy and the housing market

Economic growth in Canada was very strong in the fourth quarter of 2021 at 6.7%, which is stronger than the Bank’s previous projection and confirms its view that economic slack has been absorbed
Both exports and imports have picked up, consistent with solid global demand
In January 2022, the recovery in Canada’s labour market suffered a setback due to the Omicron variant, with temporary layoffs in service sectors and elevated employee absenteeism, however, the rebound from Omicron now appears to be “well in train”
Household spending is proving resilient and should strengthen further with the lifting of public health restrictions
Housing market activity is “more elevated,” adding further pressure to house prices
First-quarter 2022 growth is “now looking more solid” than previously projected

Canadian inflation and the impact of the invasion of Ukraine

CPI inflation is currently at 5.1%, as the BoC expected in January, and remains well above the Bank’s target range
Price increases have become “more pervasive,” and measures of core inflation have all risen
Poor harvests and higher transportation costs have pushed up food prices
The invasion of Ukraine is putting further upward pressure on prices for both energy and food-related commodities
Inflation is now expected to be higher in the near term than projected in January
Persistently elevated inflation is increasing the risk that longer-run inflation expectations could drift upwards
The Bank will use its monetary policy tools to return inflation to the 2% target and “keep inflation expectations well-anchored”

Global economy

Global economic data has come in broadly in line with projections in the Bank’s January Monetary Policy Report
Economies are emerging from the impact of the Omicron variant of COVID-19 more quickly than expected, although the virus continues to circulate and the possibility of new variants remains a concern
Demand is robust, particularly in the United States
Global supply bottlenecks remain challenging, “although there are indications that some constraints have eased”

Looking ahead

As the economy continues to expand and inflation pressures remain elevated, the Bank’s Governing Council made a clear point of telling Canadians to expect interest rates to rise further.

The Governing Council also announced it will consider when to end its “reinvestment phase and allow its holdings of Government of Canada bonds to begin to shrink.”

The resulting quantitative tightening (which central bankers framed as “QT” rather than the previous term “QE” for quantitative easing) would complement increases in the Bank’s policy-setting interest rate. The timing and pace of further increases in the policy rate, and the start of QT, will be guided by the Bank’s ongoing assessment of the economy and its commitment to achieving a 2% inflation target.

BoC’s next scheduled policy announcement is April 13, 2022. We will update you following that announcement and as always, you can find other important capital market insights on the Resources page of this website.