Bank of Canada: How high is its policy rate likely to go?

Taking current and possible future trends into account, 5% remains the most likely peak for the Bank of Canada’s policy rate, according to CIBC Capital Markets.

A main factor in this expected development is the apparent lack of “any real cooling in the labour market,” said Andrew Grantham, senior economist at CIBC.

“While job vacancy rates have continued to fall, the latest labour force report suggests that May’s drop in employment was nothing more than a statistical anomaly related to volatility in youth employment,” Grantham said. “The rebound in jobs during June, and an unemployment rate that is still low relative to pre-pandemic norms, may have just tipped the scales towards an immediate hike.”

More importantly, the impacts of previous hikes have yet to truly manifest in the Canadian economy, making a 5% stopping point for the BoC’s benchmark interest rate a sensible choice.

“Interest rates have already risen a lot over the past 15 months, but the lags involved between rates rising, the economy slowing, and finally inflation decelerating, mean that the full effects of these hikes have not yet been felt,” Grantham said.

“While the aggressive ‘front-loading’ of rate hikes last year was at least partly necessary for policy to catch up with the speedy post-pandemic recovery happening within the economy, the level of rates today is already higher than if the bank had started hiking earlier but at a more traditional pace.”

The economist noted that even if the central bank had hiked its rates by 25 basis points in every meeting from July 2021 to June 2023, the hypothetical overnight rate would only be 4.25%.

“The main point… is that interest rates are already at, or even above, levels that would have prevailed under a more normal hiking cycle,” Grantham said. “Any moves from here should be about fine-tuning policy and responding to most recent data.”