Bank of Canada all but certain to raise lending rates this week — with more hikes to come

The Bank of Canada is expected to raise its benchmark interest rate by half a percentage point on Wednesday, a move designed to rein in inflation, running at its highest level in decades.

There's a virtually unanimous view among economists that the bank will move its benchmark lending rate to 1.5 per cent on Wednesday, the second such hike in a row and a crystal clear signal that the pandemic-induced era of cheap money has come to an end.

While that's bad news for anyone who owes money or wants to borrow some, it's not hard to see why the bank feels compelled to act.

The price of everything from food to gasoline and housing has exploded during the pandemic, as supply and demand imbalances brought about because of COVID-19 have coupled with record-setting amounts of stimulus cash to fuel inflation.

Officially, Canada's inflation rate sits at 6.8 per cent, its highest level in 30 years. Costs for basic necessities, like putting food on the table and keeping a roof over one's head, have gone up by even more, with food and shelter rising 9.7 and 7.4 per cent, respectively, in the past year.

The current inflation rate for necessities is two to three times higher than what the bank likes to see. While low interest rates aren't the only factor driving up inflation, the central bank is feeling the pressure to move swiftly to cool things down.

Nathan Janzen, an economist with RBC, thinks Canada's central bank is on track for a series of larger-than-normal hikes in a row, until its rate gets to roughly three per cent. Canada's benchmark interest rate hasn't hit that level since the 2008 financial crisis.  

"The looming question is whether rates need to rise above that neutral range to get inflation back under control," Janzen said.

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Inflation is obvious in Canada, but the reasons for it are a little more complicated. Prices at gas stations rose above $2 a litre in many parts of the country, while the cost of pasta is up 20 per cent at grocery stores. Canada’s official inflation rate hit a three-decade high in April, rising at a 6.8 per cent annual pace. But what’s behind these sticker-shocking prices can’t be explained by any one factor; the ongoing war in Ukraine, climate change and even some unprecedented monetary policy all contribute to the current situation. Today, CBC business reporter Pete Evans joins Front Burner to sort through the myriad reasons prices keep rising and why the current inflation in Canada doesn’t mean the federal COVID-19 stimulus was a mistake.

It's hard to overstate the impact that interest rates more than twice as high as they were before the pandemic would have on the broader economy. The most obvious impact would be in the housing market.

After increasing at a torrid pace for most of the pandemic, Canadian house prices have started to cool down ever since the central bank made its first tiny rate hike in March. Sales are down sharply just about everywhere, and selling prices have inched lower too, down from an all-time high average of $816,000 in February to $746,000 in April. 

May's numbers are expected to show that downward pace quickening, and that's before the impact of this week's expected hike is factored in.

WATCH | Here's what a central bank rate hike could do to the housing market:

How the Bank of Canada rate hike could impact house prices

3 years ago

Duration 5:58

Personal finance expert and Credit Canada CEO Bruce Sellery answers questions about the latest Bank of Canada interest rate hike and what it could mean for house prices.

Sung Lee, a mortgage broker with rate comparison website Rates.ca, said some buyers are already getting cold feet. And many of those who are still willing to jump in are finding themselves able to afford less than they anticipated.

"We've seen a slight dip in mortgage inquiries after the Bank of Canada first raised rates, which seems to be in line with the recent slowdown in the real estate market," Lee said in a recent commentary.

Anyone wishing to get a mortgage to buy a home must have their finances stress tested in order to discern if they can handle higher rates. And even the relatively small rate hikes that have happened so far have many would-be buyers failing to meet the new, higher bar. They are then compelled to buy something more affordable — or hold off entirely.

Currently, most borrowers have their finances tested as if mortgage rates were 5.25 per cent; that's quite a bit higher than the level many Canadians would get from a lender right now.

But as those real lending rates inch higher, the bar for the stress test gets raised too. This causes some prospective buyers "to either hold off on purchasing or turn to alternative methods to raise the amount of mortgage they can afford, such as credit unions or private lenders," Lee said. 

Analyst urges 'aggressive' rate hikes

Canada is far from the only central bank trying to battle inflation with higher lending rates, but strategists at Dutch bank ING say the Bank of Canada has a harder job than some because its economy is so heavily impacted by what its neighbour to the south does.

"To generate the same degree of monetary tightening, the Bank of Canada tends to need to be more aggressive on policy rate increases," James Knightley and Francesco Pesole wrote in a commentary last week.

"We would argue that you cannot dismiss the possibility of a 75-point hike given the current macro environment."

A hike of that size would take lending rates to where they were before the pandemic started — when the central bankers around the world were cautiously trying to get interest rates back up to something approaching normal.

More than two years into a pandemic, what "normal" means now is anyone's guess, but bank watchers agree that the old rules will likely no longer apply.