Canada chooses a hawkish route

Normally, the Bank of Canada aims to keep inflation at a modest 2%, just like the Federal Reserve does.

So when Canada’s inflation rate hit 7.7% in May — its highest rate in nearly 40 years — it called for a much more aggressive response.

The country’s central bank typically tinkers with its key policy rate in modest 0.25% increments, but Macklem announced July 13 that it would surge a full 1%.

That brings the Canadian overnight rate to 2.50%.

An increase of this size hasn’t happened since 1998. And while it’s going to have immediate implications for consumers, experts say it’s a necessary step for putting out the flames of inflation — even if it extinguishes Canada’s economy in the process.

Simply add Capital One Shopping to your browser, and shop like normal. This free tool does the work for you.

Install Capital One Shopping

Why Canada is being so aggressive

May's inflation figure was even higher than the central bank was anticipating, which means Macklem’s main concern right now is preventing high inflation from becoming entrenched.

It’s a difficult balance all central banks need to weigh. The Bank of Canada, like the Fed, chose to keep rates close to zero for the first two years of the pandemic to help boost the economy, but creeping inflation has forced them to act.

Typically, analysts would worry these supersized hikes could push the country into a recession.

Moshe Lander, an economist with Montreal's Concordia University, says a hike of this size is not only a “depressing move” but could also “take some of the starch out of the Canadian economy in the process.”

Although Lander has reservations about such a big hike, he can’t deny that inflation remains stubbornly high despite the bank’s efforts these last few months.

“And so [the bank has] no choice but to go nuclear and go with that depressing increase,” says Lander.

The risks of such a hawkish move are worth taking, writes the Bank of Montreal’s chief economist, Douglas Porter.

“Recession calls have become mainstream for the broader economy,” Porter wrote in a recent note to clients.

“But those rising risks simply cannot and will not sway the bank from soldiering on; the risk of recession has to be a secondary consideration to the reality of red-hot inflation.”

Canada and the U.S. move slowly compared to others

This is the Bank of Canada’s fourth interest rate increase in five months, and Macklem has already signaled it’s not done yet.

Many other countries outside of North America have been forced to take similarly aggressive steps.

In fact, the major criticism from Canadian economists has been that the Bank of Canada waited too long to pull out the big guns compared to other central bankers.

“All they have done today is to tiptoe into the neutral policy setting, when what Canada needs to counter inflation is something more deeply into restrictive territory,” TD economist James Orlando told the Financial Post.

“Front-loading would have been like the (Reserve Bank of New Zealand) and (Bank of Korea) did when they began hiking last summer.”

The Reserve Bank of New Zealand announced its first interest rate hike in October of last year. And while the economy has started to show some signs of slowing, Governor Adrian Orr insists it was correct for the bank to move early and fast, saying it remains “resolute in its commitment” to bring down inflation.

Similarly, the Bank of Korea started raising rates in November 2021 and announced its sixth hike July 12, bringing the overnight rate to 2.50% there.

Sign up for Credit Sesame and see everything your credit score can do for you, find the best interest rates, and save more money at every step of the way.

Get Started—100% Free

How might this affect the Fed’s next announcement?

If Canadian inflation is running as hot as a “four-alarm fire” — as BMO’s Porter so eloquently put it — then the U.S. is dealing with a five-alarm inferno.

On the same day as Macklem’s announcement, the Bureau of Labor Statistics released updated inflation figures for the month of May.

At a staggering 9.1%, U.S. inflation is at a 41-year high.

Although Powell announced a 0.75% increase in May — the largest bump in nearly 30 years — American economists have also criticized the bank for waiting too long to act.

Back in June, Powell said July’s announcement was likely to come down to a 0.50% or 0.75% increase, but the news from up North along with the scorching-hot inflation numbers may push him to act even more aggressively.

By Wednesday afternoon, investors were pricing in over a 75% chance of a 100 basis points hike in July, according to the CME Fedwatch tool.

With the Fed’s overnight rate now sitting at 1.75% and plans to raise that to at least 3.4% by the end of the year, it’s all but certain there will be an increase announced later this month.

What’s less certain now is what that number will be.

Compare car insurance and save up to $500 a year

If you haven't compared car insurance recently, you're probably paying too much for your policy. Getting quotes from multiple insurers used to be time-consuming, but today's technology makes it easy.

Using a free site like Pretected is easy and could help you save up to $500 a year on car insurance. In mintues, their "smart matching" system will provide tailor-made quotes from insurers that can meet all of your coverage needs - and your budget.

Stay protected on the road and find more affordable car insurance in minutes with Pretected.

About the Author

Sigrid Forberg

Sigrid Forberg

Associate Editor

Sigrid’s current role is associate editor, and she has also worked as a reporter and staff writer on the MoneyWise team.

What to Read Next

Disclaimer

The content provided on MoneyWise is information to help users become financially literate. It is neither tax nor legal advice, is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. We make no representation or warranty of any kind, either express or implied, with respect to the data provided, the timeliness thereof, the results to be obtained by the use thereof or any other matter.