BoC open to hiking interest rates past 3%

The deputy governor of the Bank of Canada says it may need to raise its key interest rate to 3% or beyond to ensure inflation doesn’t settle in for the long haul.

“We’re scared that this inflation becomes entrenched,” Paul Beaudry told reporters Thursday afternoon.

In an earlier speech to the Gatineau Chamber of Commerce, he said the likelihood of even higher consumer prices on the horizon means the central bank will consider pushing its policy rate at least to the top end of its “neutral” range — between 2% and 3%, which neither spurs nor hampers growth.

“Price pressures are broadening and inflation is much higher than we expected and likely to go higher still before easing,” Beaudry said Thursday morning.

“This raises the likelihood that we may need to raise the policy rate to the top end or above the neutral range to bring demand and supply into balance and keep inflation expectations well anchored.”

The annual pace of inflation rose to 6.8% in April, the fastest year-over-year rise in 31 years as the price of goods from gas to groceries continued to climb.

The groundwork for more oversized hikes comes after the Bank of Canada on Wednesday raised its benchmark rate, bringing it to 1.5%. The move marked the first back-to-back half-point hikes since scheduled rate announcements began in 2000. In April, the bank increased the rate by half a percentage point to 1%.

Beaudry said supply chain disruptions during the pandemic lasted longer than the central bank anticipated, exacerbated by unexpected events like Russia’s invasion of Ukraine and Covid-19 lockdowns in China.

He said some Canadians feel inflation is already feeding on itself, driven by expectations of even costlier goods and services as wages rise to meet mounting prices in a self-reinforcing cycle. But he maintained that pandemic-related supply issues are the main driver of eye-popping price tags and that higher rates will bring down demand relative to supply, easing inflationary pressures.

The bank makes changes to its trendsetting interest rate in an effort to control inflation with a target of 2%. Rate hikes aim to cool borrowing and spending by boosting the cost of loans linked to the benchmark, including variable-rate mortgages.

“The longer inflation remains well above our target, the more likely it is to feed into inflation expectations, and the greater the risk that inflation becomes self-fulfilling,” Beaudry said.

“History shows that once high inflation is entrenched, bringing it back down without severely hampering the economy is hard.”

Global pressures along with low unemployment rates at home will likely push inflation well past the bank’s previously projected rate of nearly 6% for the first half of the year, it said Wednesday.

Beaudry said spend-happy households and businesses are overheating the economy, though signs of fallout from the three interest rate hikes since March are already visible, particularly in the housing market.

Home sales dropped 12.6% in April from March, and sat more than one-quarter below sales figures from April 2021, according to the Canadian Real Estate Association. The home price index dipped 0.6% month over month.

“We think we can kind of rein this in without necessarily getting into a recession-type area,” Beaudry told reporters.

Optimism around inflation is not so broad. A March survey from the Canadian Federation of Independent Business found that small business owners expected their average price would climb 4.7% in 12 months.

“That’s really what’s worrying us,” Beaudry said, referring to one-to-two-year inflation expectations. “The good part is, looking further out — five years out — people have confidence that we will bring it back.”

The bank is also easing pandemic-era stimulus measures by continuing so-called quantitative tightening, begun in April, as the government bonds it holds are no longer being replaced when they mature.

Asked whether Pierre Poilievre, widely seen as the frontrunner in the federal Conservative leadership race, was fair in demanding Bank of Canada governor Tiff Macklem be fired for acting as the Liberal government’s “ATM,” Beaudry replied: “No … We’re not in the business of politics.

“We haven’t managed to keep inflation at our target, so it’s appropriate that people are asking us questions,” he added.

The bank expects its holdings of Canadian government bonds, which sat at $440 billion at the end of last year, to fall to $280 billion by the end of 2023, a 35% drop over two years.