In a Surprise Move, Overnight Policy Rate Jumps by 25 Basis Points to 4.75%, Following a Similar Leap in Fixed Mortgage Rates
The Bank of Canada, in an unexpected move today, raised the prime lending rate in an effort to tackle inflation, signalling its firm resolve to bring inflation down to the 2% target. This move comes in the wake of the recent hike in the overnight policy rate by 25 basis points to 4.75%. The rise in fixed mortgage rates that occurred even before today’s move, driven by the increase in market-determined bond yields following the US debt-ceiling debacle, will now be followed by a similar increase in variable mortgage rates.
Bank of Canada’s Operations and Role in Setting Interest Rates
The Bank of Canada, the country’s central bank, plays a pivotal role in maintaining the economic and financial well-being of the nation. One of its primary functions is to set the country’s monetary policy to ensure the stability of prices and the economy.
The Bank’s key tool for implementing monetary policy is the setting of the key interest rate, also known as the overnight rate. This rate is the interest rate at which major financial institutions borrow and lend one-day (or “overnight”) funds among themselves. Changes in the overnight rate influence other interest rates, such as those for consumer loans and mortgages, which impact spending decisions of households and businesses, thereby affecting overall economic activity and inflation.
Inflation and Interest Rates: The Delicate Balance
Today, the Bank of Canada cited an “accumulation of evidence” that includes stronger-than-expected first-quarter output growth, an uptick in inflation, and a rebound in housing-market activity as justification for its action. The bank stated, “Monetary policy was not sufficiently restrictive to bring supply and demand into balance and return inflation sustainably to the 2% target.”
This move by the bank indicates its concern that the economic demand is outstripping supply, creating an inflationary environment. By raising the prime lending rate and the overnight rate, the bank aims to slow down economic activity, reducing inflationary pressure.
Canada Follows Australia’s Lead
This move by the Bank of Canada mirrors a similar action by the Reserve Bank of Australia earlier this week. However, while the Australian economy was already showing signs of slowing down, the Canadian economy exhibited a robust 3.1% growth in the first quarter and is likely to continue this upward trend in Q2, bolstered by a strong rebound in housing.
The Road Ahead
Looking ahead, the next Bank of Canada decision date is only five weeks away. While two labour force surveys and one inflation report will be released in this period, the likelihood of another rate hike before the end of the year is high. The bank concluded in their press release that, “Overall, excess demand in the economy looks to be more persistent than anticipated.”
If the economic data remains robust over the next few weeks, another 25 basis point rate hike is likely in July. Deputy Governor Beaudry is expected to elaborate on today’s decision in his Economic Progress Report tomorrow.
While the Bank’s actions may cause some immediate financial discomfort, they reflect a concerted effort to maintain economic stability and prevent inflation from spiraling out of control. The Bank of Canada is determined to balance supply and demand in the economy, a key step in returning inflation to the 2% target.