Quick take

Bank of Canada raises rates amidst geopolitical tensions

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  • The Bank of Canada increased its target for the overnight rate to 0.5 per cent, with the Bank rate at 0.75 per cent and the deposit rate at 0.5 per cent.
  • CPI inflation which sits at 5.1 per cent, remains above the target range while core measures have continued to rise. Poor harvests and increase in transportation costs have pushed up food prices. Meanwhile, geopolitical tensions have also put upward pressure on prices for both energy and food-related commodities. Therefore, the Bank expects inflation to be higher in the near term than projected in January.
  • At 6.7 per cent, economic growth in the final quarter of 2021 was stronger than the Bank’s projection, which confirms their view that slack in the economy has been absorbed.
  • As the Canadian economic recovery continues and inflationary pressures remain elevated, the Governing Council expects interest rates to rise further. It is to be determined when the Governing Council would consider exiting the reinvestment phase and reducing its holdings of Government of Canada bonds.

Key insights:

  • The rate hike finally came! And it had to be done. However, the impact this has on Canadian households will be evident soon. Canadians have some of the highest debt levels per household among Western countries (owe $1.77 for every dollar they earn). As such, any incremental increase in rates, while necessary, will squeeze leveraged Canadian households.
  • Given Russia’s invasion of Ukraine and subsequent sanctions imposed on Russia by western nations, we believe the Bank of Canada should slow down further rate hikes this year. This is because:
    1. Concerns over energy supplies from Russia have caused oil prices to rise (US $110 at the time of writing), with further increases on the cards. While this benefits Canadian oil exports, higher oil prices will most likely end up putting upward pressure on the Loonie, slowing our non-commodity exports.
    2. Canadian consumers will face higher energy and food prices due to the conflict. As a result, we expect consumer and business confidence to drop. Still, the Bank of Canada can do little to curb inflationary pressures or dropping confidence arising from supply shocks like the ongoing war.
    3. Slowing down the pace of rate hikes will give the Bank more time to observe how global geopolitics are unfolding and assess the economic impact on Canada. It is a tricky path to navigate, but the Bank needs to ensure that the Canadian economy does not face extra hurdles through aggressive rate hikes, especially during the closing stages of the pandemic.

Russian Invasion of Ukraine: Access the latest insights

Sasan Fouladirad

Sasan Fouladirad

Economist

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