Bank of Canada raises its interest rate to 2.5%


Concerned that four-decade-high inflation is becoming entrenched, the Bank of Canada increased interest rates by a full percentage point, bolstering efforts to withdraw support. In response to expectations that four-decade-high inflation would continue, interest rates have risen.

Bank of Canada Building

In a decision announced in Ottawa on Wednesday, the central bank governor, Tiff Macklem, increased the benchmark interest rate to 2.5% and suggested that more increases are anticipated. The 100 basis point gain is the largest since 1998. 75 basis points was the figure expected by markets and experts. The unanticipated monetary shock illustrates politicians’ dread of inflationary expansion. As a consequence, they have decided to move swiftly despite the knowledge that doing so will cause significant economic suffering. They thought that if inflation kept going up, it would cause wages to go up and prices for goods and services to go up in a way that would be hard to stop.

Bank of Canada

Because of the close relationship that exists between variable rate mortgages and the rate that is set by the central bank, the housing market will be the first to suffer the consequences of increasing rates. As a result of demand being spurred by record-low borrowing rates and prices reaching all-time highs, the housing market in Canada was red-hot throughout most of the duration of the pandemic. This trend, however, began to reverse in the first quarter of this year, when the central bank issued a warning about upcoming rate rises. This took the wind out of the sails of the insatiable demand that had been building up. Homebuyers who are considering making a purchase of their own must first pass a financial “stress test” to demonstrate that they are able to manage higher interest rates. The rate hike on Wednesday will bring the minimum required for passing this test up to around 7 percent for loans with fixed rates and 6 percent for loans with variable rates. In the event that borrowers do not pass the stress test, lenders are required to restrict the amount of money they would grant to such borrowers until those borrowers meet the criteria.

Bank of Canada front view

The Federal Reserve was obliged to increase interest rates by 75 basis points in order to combat rising inflation, which reached 9.1 percent in June. According to a report released earlier on Wednesday by the Labor Department, the annual rate of inflation in the United States reached 9.1 percent in June. In the accompanying monetary policy report, Bank of Canada policymakers raised their near-term inflation forecasts yet again, predicting price pressures of around 8% in the second and third quarters of this year.This was included in the report since the forecasts were included in the accompanying monetary policy update. The inflation rate will decrease to 7.5% by the end of the year but will not return to the 2% target until 2024. In addition, government authorities reduced their projections for Canada’s economic growth. They now anticipate that the gross domestic product will increase by 3.5% this year and 1.8% in 2023, a decrease from their prior projections of 4.2% and 3.2%, respectively. This is because monetary policy is tightening its hold on economic activity and global growth is declining.

The bank has compiled data on a possible new risk scenario that includes “self-reinforcing wage increases and price spirals.” In addition, they claim that the longer inflation continues “far over” their 2% objective, the more likely it is that this scenario will materialize. In the report’s appendix, the bank acknowledged that its inflation projections for the previous year included errors. It ascribed the vast majority of errors to global external forces but also cited the rise in local home values. During the time of the outbreak, the bank noted that the “unsustainable speed” of real estate market activity had drastically reduced. It is anticipated that between now and 2023, both property sales and prices will fall.

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