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The Bank of Canada increased its target interest rate to 1%

Bank of Canada engraved into a stone wall.

Key takeaways

  • The Bank of Canada increased its target for the overnight rate to 1.0%.
  • Quantitative tightening will commence on April 25 and further rate increases are coming.
  • The invasion of Ukraine, the ongoing pandemic continue to put upward pressure on inflation.

As most anticipated, the Bank of Canada (BoC) raised its target for the overnight rate by 0.5% to 1.0%. Furthermore, the Bank announced its intentions to begin quantitative tightening as of April 25 – maturing Government of Canada bonds held by the BoC will no longer be replaced.  

With inflation well above the BoC’s 2% target and the Canadian economy demonstrating excess demand, the Bank also restated that interest rates will need to rise further along with its quantitative tightening plans. In line with expectations, we expect between 6 to 8 more 0.25% rate hikes for 2022.

Global growth remains solid

The BoC’s latest forecast has global growth at 3.5% in 2022 (revised from 3.6%), 2.5% in 2023 (revised from 3.4%) and 3.2% in 2024. While the 2022 projection remains roughly the same, 2023 global growth was revised down due to the invasion of Ukraine, the ongoing pandemic and the anticipation of financial conditions becoming even tighter. Noted by the Bank:

“The war in Ukraine is disrupting the global recovery, just as most economies are emerging from the impact of the Omicron variant of COVID-19. European countries are more directly impacted by confidence effects and supply dislocations caused by the war.”

“China’s economy is facing new COVID outbreaks and an ongoing correction in its property market.”

“In the United States, domestic demand remains very strong and the U.S. Federal Reserve has clearly indicated its resolve to use its monetary policy tools to control inflation. As policy stimulus is withdrawn, U.S. growth is expected to moderate to a pace more in line with potential growth.”

Canadian growth is robust

Similarly, the BoC projects Canadian growth at 4.2% in 2022 (revised from 4.0%), 3.2% in 2023 (revised from 3.5%) and 2.2% in 2024. Growth is strong and the Canadian economy is moving into excess demand. Employment is strong and wage growth has returned to pre-pandemic levels.

Vaccination rates remain high and have minimized negative health and economic impacts. As a result, consumer spending is strengthening with restrictions easing. Exports and business investment continue to recover, supported by foreign demand and higher commodity prices.

Interest rates are rising to contain inflation

The BoC stated that “Businesses increasingly report they are having difficulty meeting demand, and are able to pass on higher input costs by increasing prices.” Additionally, the Bank raised inflation expectations to 5.3% for 2022 (from 4.2%) and 2.8% for 2023 (from 2.3%). The Bank expects inflation to normalize towards its 2.0% target in 2024. However, it did warn that there is an increasing risk that expectations of elevated inflation could become entrenched.

Strong global demand, rising energy and foodstuff prices along with ongoing supply disruptions continue to support inflation.  

The Bank of Canada announcement was in-line with our expectations

Equity markets traded higher and bond yields traded lower on Wednesday. It’s important to recognize that the bond market is already aggressively pricing in expected rate hikes from central banks. While the BoC announcement met expectations, investors have moderately reduced their expectations for future rate hikes given core inflation (ex-energy and food) being less robust than anticipated in the U.S. and economic growth appearing to slow. The Canadian dollar dipped to 4-month lows versus the U.S. dollar but spiked higher following the interest rate and quantitative tightening announcement.

Recently, we reduced our overall allocation to equities to an underweight position. The BoC’s statement supports our view – financial conditions and government policy continue to tighten and risks to the global economy have increased due to the conflict in Ukraine. We are now slightly underweight Canadian equities, slightly overweight U.S. equities, underweight international equities and neutral on emerging market equities.

On the fixed income side, near-term volatility will continue to be elevated for Canadian bond yields. We still believe that yields already account for the additional rate increases referenced in the Bank’s announcement. We remain interest rate neutral and continue to target a flattening of the U.S. and German yield curves. Our recent positioning adjustments to the fixed income and cash portion of our portfolios was designed to lower overall portfolio risk and reflect current conditions. 

While interest rates have risen materially in 2022, it is important to remember that rates remain low historically. However, if you are wondering how rising rates will impact your finances beyond your investments, here’s what interest rate increases could mean for physicians. If you have any questions about this announcement, our positioning or how it will impact you, please contact your MD Advisor*.

The BoC’s next interest rate announcement is scheduled for June 1, 2022.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec).

The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.

About the Author

Wesley Blight, CFA, CIM, FCSI, is an Assistant Vice President with the Multi-Asset Management team. He is responsible for the investment results of the firm’s fixed income and multi-asset products.

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