The Bank of Canada shocks with 100 basis points increase in rates

The Bank of Canada shocked financial markets with a surprise increase of 100 basis points in the official interest rate.

Will this be enough to stop inflation?

Here’s an excerpt from the July 13, 2022 announcement:

 

“With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today. The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank’s ongoing assessment of the economy and inflation. Quantitative tightening continues and is complementing increases in the policy interest rate. The Governing Council is resolute in its commitment to price stability and will continue to take action as required to achieve the 2% inflation target.”

 

Mortgage, HELOC, prime and auto loan rates will rise rapidly in the next few months, as the BOC indicates that inflation will be persistent for a time. Price stability will come at a high cost to Canadian borrowers.

As recently as June, the Bank of Canada was still sticking to its belief that inflation would moderate on its own without needing anything more than an orderly and steady adjustment in rates by the central bank.

This week, the Bank of Canada apparently changed its view, and now believes that the financial markets need to be shocked with substantially higher rates in order to get inflation under control, even if this means triggering a recession.

But these moves will not work right away.

The BOC failed to mention one of the most underrated factors in inflation — the “shelter” component of the CPI. I wrote about this in a previous post.

Shelter costs are likely to be more persistent and harder to control. Food and energy are the most volatile items, and those measures may drop on their own as the price of crude oil comes down and supply chain issues moderate. But shelter costs are stubborn, and shelter makes up 40 percent of “core” inflation (CPI ex food and energy).

A full 20 percent of CPI is “owned accommodation” with these elements:

  • Mortgage interest cost 3.4%
  • Homeowners’ replacement cost 5.61%
  • Property taxes and other special charges 3.40%
  • Homeowners’ home and mortgage insurance 1.38%
  • Homeowners’ maintenance and repairs 1.66%
  • Other 4.26%

 

Source: Statistics Canada Table 18-10-0007-01

The two big ones — mortgage interest and replacement cost — are still rising rapidly. And the Bank of Canada 100 basis point increase on Wednesday guarantees that mortgage interest cost will rise even faster, as the banks and other lenders increase their lending rates.

Canada’s next inflation number release (July 20, 2022) will likely be above 8 percent and will remain in that range for the next few months. US CPI was 9.1 percent for June.

Unfortunately, the BOC will need to announce many more interest rate increases in the battle to stop inflation.

 

Hilliard MacBeth

 

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