For the sixth time this year Canada’s central bank is raising interest rates in a bid to rein in inflation.
The Bank of Canada’s overnight rate was increased by 50 basis points on Wednesday to 3.75 per cent. That rate is what banks are charged for short-term loans but has an impact on the rates that Canadians get from their own lenders for things like car loans and mortgages.
Raising interest rates is a tactic to slow inflation, which reached a 40-year high at just over eight per cent in June. The rate has been falling in recent months and is now below seven per cent.
“The textbook economics is if you raise the interest rate people will consume less and spend less and that will dampen the economy so that prices and inflation will go down. That is basically the goal here,” said Paritosh Ghosh, head of economics at Red Deer Polytechnic.
Recent interest rate hikes appear to have cooled inflation but whether it will be enough is tough to say, said Ghosh.
“Whether this will bring the inflation to our desired two per cent level is a different question, but that is the goal here by the central bank,” said Ghosh.
Among the challenges is the nature of the current inflation surge.
“This time inflation is a little bit different than previous inflation,” said Ghosh.
Supply chain issues have been a significant driver of rising costs and the war in Ukraine has further pushed up prices.
“These are two factors we cannot fix by interest rates, so I don’t know if it will go down to that (two per cent level). It might take a while.
“That’s the reason why inflation is almost in G-7 countries and everywhere. These two factors are common for every country.”
Many past inflations have been more country-specific and driven by economic issues particular to that nation, he added.
In announcing the new rates, the Bank of Canada said “inflation around the world remains high and broadly based. This reflects the strength of the global recovery from the pandemic, a series of global supply disruptions, and elevated commodity prices, particularly for energy, which have been pushed up by Russia’s attack on Ukraine.”
The strong U.S. dollar has also been feeding inflation in many countries.
“In Canada, the economy continues to operate in excess demand and labour markets remain tight. The demand for goods and services is still running ahead of the economy’s ability to supply them, putting upward pressure on domestic inflation,” says the central bank. “Businesses continue to report widespread labour shortages and, with the full reopening of the economy, strong demand has led to a sharp rise in the price of services.”
Inflation is expected to ease as supply and demand pressures are rebalanced, global supply issues fade and the impacts of higher commodity prices dissipates.
The central bank warned that additional interest rates are likely coming.
“Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Governing Council expects that the policy interest rate will need to rise further.
“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.”