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As expected, the Bank of Canada increases its target interest rate to 1.5%

Green paper Canadian money with Bank of Canada signature and the number twenty below it.

Key takeaways

  • The Bank of Canada increased its target overnight rate to 1.5% and will continue quantitative tightening.
  • The Bank is prepared to raise rates further if needed to bring long-term inflation in line with its 2% target.
  • Ongoing supply disruptions is weighing on economic activity while boosting inflation.

As most anticipated, the Bank of Canada (BoC) once again raised its target for the overnight rate by 0.5% to 1.5%. Its quantitative tightening program will also continue, where maturing Government of Canada bonds held by the BoC will not be replaced.

Of note, the BoC stated that “the pace of further increases in the policy rate will be guided by the Bank’s ongoing assessment of the economy and inflation, and the Governing Council is prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.” In line with market expectations, we still anticipate an additional three-to-five 0.25% rate hikes for the rest of the year, with two of those (i.e., 0.50%) expected in July.

Inflation remains a key risk

Measures of inflation continue to rise in Canada and across the globe, largely driven by higher food and energy prices. The Bank stated that the risk of elevated inflation becoming entrenched has risen. Tracking well above the Bank’s own forecasts, Canadian CPI inflation hit 6.8% in April and is likely to move higher in the near term before beginning to normalize.

Pandemic lockdowns and the invasion of Ukraine are slowing the global economy and fanning inflation

In a one-two punch to the gut, the increase in inflation is happening while the global economy slows. Ongoing supply chain disruptions brought about by China’s pandemic-related lockdowns and the Russian invasion of Ukraine has increased uncertainty, weighed on economic activity and placed upward pressure on energy and commodities prices.

Conditions in Canada remain strong, but rates will need to move higher

The BoC reported GDP growth of 3.1% in the first quarter of 2022 – in line with the Bank’s projection from the April Monetary Policy Report (MPR). The Bank stated that the Canadian economy is “clearly operating in excess demand,” meaning demand is still outpacing supply.

Growth in the second quarter is expected to be strong as well. Companies are reporting labour shortages, wage growth is picking up, housing market activity is moderating, consumer spending remains robust, and exports are expected to strengthen.

The announcement was in line with expectations

Global equity markets traded lower, and bond yields higher on Wednesday (June 1, 2022). It’s important to recognize that the decision was widely anticipated and already priced-in to markets; however, the language supporting future hikes is viewed as modestly hawkish.

We remain underweight equities and fixed income in our portfolios. Our view is supported by the BoC’s actions as financial conditions and monetary policy continue to tighten and risks associated with the pandemic and the conflict in Ukraine persist. We recently increased our allocation to cash as we are slightly underweight Canadian equities, overweight U.S. equities, underweight international equities and underweight emerging market equities.

For the fixed income side of the portfolios, we are targeting a flatter yield curve in Europe with the European Central Bank poised to move away from emergency-level rates. We also have a slightly long duration (interest rate sensitivity) bias in North America with expectations that longer-dated yields will come in from current levels as central banks tighten lending conditions amidst slowing economic growth.

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 July 13, 2022, and it will be accompanied by the latest MPR.

* 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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