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Bank of Canada rate increased to 3.75%

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Key takeaways

  • The Bank of Canada increased its target overnight rate by 0.5%.
  • Most were expecting a 0.75% hike.
  • The Bank of Canada reiterated that it expects interest rates to rise further.

In its ongoing efforts to tame inflation, the Bank of Canada (BoC) raised its target for the overnight rate by 0.5%. In line with our expectation, this sixth consecutive hike brings the overnight rate to 3.75%. As a reminder, we started from 0.25% back in March. The move surprised some as most expected a 0.75% increase this week. Quantitative tightening will also continue, where maturing Government of Canada bonds held by the BoC will not be replaced.

Despite CPI inflation coming down from 8.1% to 6.9%, the BoC is still concerned that inflationary price pressures remain. “The Bank’s preferred measures of core inflation are not yet showing meaningful evidence that underlying price pressures are easing. Near-term inflation expectations remain high, increasing the risk that elevated inflation becomes entrenched,” said the Bank.

To close its Wednesday statement, the BoC reiterated that it “expects that the policy interest rate will need to rise further.”

Inflation should normalize by the end of 2024

A combination of the pandemic recovery, ongoing supply issues, elevated commodity prices, the conflict in Ukraine and a strengthening U.S. dollar continues to prop-up inflation. However, the Bank expects inflation to ease as tighter monetary policy, a.k.a. higher interest rates, subdues demand, as global supply issues get resolved and the effect of recently higher commodity prices dissipates. 

The bank still projects that CPI inflation will come down to approximately 3% by the end of next year and hit its 2% long-term inflation target by the end of 2024. With that said, rates will likely still need to rise in the short term. “Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding,” the Bank explained.

Expect slower growth

It’s no surprise that more restrictive monetary policy is weighing on global economic activity. In the October Monetary Policy Report, global growth expectations have been revised down since July. The BoC now expects global growth of 3% for 2022 (down from 3.5%), 1.5% for 2023 (down from 2%) and 2.5% in 2024 (down from 3%).

Canada continues to exhibit excess demand and labour shortages. We are seeing evidence that the Bank’s recent run of rate hikes is working – the housing market has sharply pulled-back and both household and business spending has softened. There has also been a slowdown in international demand. Economic growth in Canada is now expected to be 3.25% for 2022 (down from 3.5%), under 1% for 2023 (down from 1.75%) and 2% for 2024 (down from 2.5%).

Rate increases are in line with expectations

Canadian equities traded higher and Canadian bond yields dipped on Wednesday (October 26, 2022) following the BoC’s lower than expected rate hike announcement, as some see it as a signal that the Bank may be preparing to slow the pace of monetary policy tightening. Despite this, the direction that rates are heading in the near term are still in line with our expectations.

We recently increased our allocation to equities but remain underweight overall in our portfolios. Stock markets have sold off meaningfully as inflation remains stubbornly high. As financial conditions tighten to combat inflation, the fundamental outlook for the economy continues to weaken. However, the risks of being underweight equities has increased materially as positioning for a recession is now the consensus trade. In the short term, we believe it is prudent to increase our position in equities while remaining underweight overall.

On the fixed income side, we continue to target a flatter yield curve (short-term bond yields have risen more than longer-term bond yields) and a slightly long duration (interest rate sensitivity) bias in North America.

For more information about this announcement or your portfolio, please contact your MD Advisor*.

If you are wondering how rising rates will impact your finances beyond your investments, here’s what it could mean for you.

To end its meetings for 2022, the BoC’s next interest rate announcement is scheduled for December 7th.

* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.

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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