Interest Rates Just Went Higher. Now What?

By Josh Sherman | 3 minute read

The Bank of Canada’s latest rate hike was no surprise.

Experts widely anticipated the BoC would increase its key interest rate — which influences mortgage and other lending rates — on January 25, and that’s exactly what the central bank did (by 25 basis points). 

But the move raises a question: now what?

Since March 2022, the central bank has embarked on eight consecutive hikes. That’s yanked the key interest rate from an all-time low of 0.25% during the pandemic to 4.5% — where it stood around the start of the Great Recession more than a decade ago.

The latest move is part of a strategy to lower inflation. By increasing the cost of borrowing, the BoC hopes to reduce spending, which inflates the costs of goods and services. While repeated hikes may leave some wondering whether rates will go even higher, many market-watchers suggest the Bank of Canada won’t be stepping on the throttle again any time soon.

No More Interest Rate Hikes for 2023?  

“Our view has been that they are likely to hold at this stage,” Bryan Yu,  chief economist for Central 1, tells Wahi.

Central 1 forecasts the key interest rate will stay put at 4.5% for the rest of the year before the Bank of Canada starts cutting it in 2024. 

Yu notes that inflation has started showing signs of slowing. Annual inflation tracked at 6.3% in December, down from 6.8% in November, according to the Consumer Price Index, which measures the cost of things like food and shelter over time.

“I think that they (the Bank of Canada) are leaning towards really holding [rates] as they see the effects impacting the economy from the previous rate hikes,” he continues. 

Yu isn’t alone. 

“We anticipate the Bank of Canada to remain on hold for the foreseeable future,” writes Randall Bartlett, senior director of Canadian economics at Desjardins, in a recent report. 

Bartlett agrees that when the BoC does eventually make another move, it’ll be a rate cut — and it could come before the year’s end. He suggests a recession will trigger the BoC’s about-face on rates.

Economists generally predict higher interest rates will trigger a short technical recession, which is defined as two quarters of shrinking gross domestic product, this year.

What the Bank of Canada Is Saying  

The central bank is singing a different tune lately. 

As recently as October, the BoC announced that “the policy interest rate will need to rise further.” 

But, on Wednesday, policymakers sent another message: If the economy performs in line with the BoC’s expectations as per its Monetary Policy Report outlook, the bank’s governing council “expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases.” 

Inflation is forecast to sink to 3% this year before reaching the central bank’s 2% target in 2024, according to the January MPR.

The bank’s shift in language didn’t go unnoticed. As Bartlett of Desjardins puts it: “The Governing Council…watered down its hawkish language.”

However, he adds, the bank hasn’t written out the possibility of a future hike. 

“Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target,” the BoC’s January rate announcement concludes.

The central bank’s second of eight scheduled rate announcements for this year takes place on March 8.

Rapid Rate Hikes Were Necessary, Experts Say

Leading up to the January 25 policy move, experts told Wahi that the Bank of Canada had been taking the right approach by rapidly increasing the overnight rate.

Cheap financing via low rates stokes demand by encouraging borrowing. Meanwhile, supply-chain issues, like those seen during COVID-19 lockdowns, reduce inventory levels. Both forces put upward pressure on prices — as per the law of supply and demand — and have required a strong response from the central bank.

“The overnight rate is the key policy lever used by the Bank of Canada to impact demand,” Marc Desormeaux, principal economist at Desjardins, told Wahi. “Borrowing costs go higher — that has an impact on demand. That’s intended to cool the economy in a way that helps slow inflation, and that’s what’s going on right now,” he added.

As for the speed at which the BoC has acted, Moshe Lander, senior economics lecturer at Concordia University, told Wahi that the central bank had to “make up for lost time.” He suggested the BoC delayed hiking rates earlier as the pandemic-shocked economy was too sensitive and has had to cram in more hikes over a shorter period as a result.