Does rising inflation mean a Bank of Canada rate hike is on the way?

Central bank will closely weigh up a further increase, economist says

Does rising inflation mean a Bank of Canada rate hike is on the way?

An increase in Canada’s inflation rate last month came as little surprise, according to a leading economist, with further possible bumps in the road ahead as the country’s central bank bids to bring the consumer price index (CPI) towards its target rate of 2%.  

Francis Gosselin (pictured), consulting economist at nesto, told Canadian Mortgage Professional that the July spike to 3.3% – compared with 2.8% the previous month – showed that bringing the rate of inflation down further may be no easy task.

“As we edge closer to 2%, we’re going to see this kind of seesaw effect more and more,” he said. “It’s going to go up and down and up and down. It was easy to go down from 8% [the inflation rate hit 8.1% in June 2022], but that was really the oddball.

“Bringing it from 8% to 4% is quite straightforward – you just hike up the interest rate. But now, we’re seeing all sorts of other effects, one of which, suddenly, is that mortgage payments have gone up 30.6% on average. That’s putting inflationary pressure on overall prices.”

The Bank of Canada is almost fully responsible for those ballooning interest rates, having increased its benchmark rate by 475 basis points since March of last year in a bid to curb that rampant growth in the consumer price index (CPI).

There’s some room for optimism, according to Gosselin, in the fact that other measures of inflation are trending downwards even as the year-over-year growth in mortgage costs continues to rise.

“If you remove the mortgage aspect, which is directly the Bank of Canada’s fault, inflation would be 2.4%, which is the target,” he said. “So that’s good news to me.”

How will the Bank of Canada react to the July inflation figures?

The central bank has remained steadfast in its determination to bring the overall inflation rate down to 2%, with last month’s increase fuelling speculation that it could be set to introduce yet another rate hike in its next decision on September 6.

The positive overall figures despite the slight July uptick means that the Bank could likely hit pause on rate increases next month without a significant negative impact, Gosselin said.

“As far as I’m concerned, I think the strategy of the Bank is working. I think we’re seeing inflation go down. I think mortgage prices are one of the most inflationary indicators that we’re seeing, and the rates increased super-fast from March to December.

“And so we’re seeing the impact of this crazy 4% hike between March and December of 2022 – so now as we move towards January, which means we remove this 4% from our yearly analysis, just naturally by virtue of how inflation is calculated, I think we’ll see it go down.”

A further rate increase next month is by no means a surefire thing, although Gosselin added that the central bank will undoubtedly be keeping its options open.

“I would advise the Bank not to raise interest rates. We know that it takes 12 to 18 months to have its full effect on the economy, and we haven’t even fully integrated the hike from last fall,” he said. “‘Give us a break,’ basically, is my message – but again, they might do so [hike] to send a message.

“In the end, my point is even if they do increase, it will likely be a quarter point and it will not be a game changer, and it’s going to be likely the last one for a while.”

September’s rate decision to arrive before further economic data

The fact that September’s rate announcement arrives early in the month means the Bank will have to decide whether to hike or hold before further economic data from August is revealed including the unemployment rate.

That’s in contrast to the US Federal Reserve, whose decision is set to be revealed just after the midway point of the month, on September 19-20.

“Our decision happens on September 6, so it’s early in the month. We’re short one set of data,” Gosselin said. “If they would wait a week, they’d have more accurate data – whereas the US will have a full set of data that will include August in order to set their decision.”

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