Bank of Canada Increases Key Interest Rate to 2.5%

The Bank of Canada on Wednesday increased its key interest rate to 2.5 per cent – its biggest hike since 1998 and dramatically higher than the 75-basis-point jump expected by many economists.

“With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today," the central bank's statement says. The Governing Council is the Bank of Canada's policy-making body.

The Bank of Canada predicts inflation to likely remain around eight per cent, naming the war in Ukraine and ongoing supply chain issues as key drivers. It also notes that consumers and businesses expect inflation to linger, which increases the risk of elevated inflation being priced into consumer prices and wages.

“If that occurs, the economic cost of restoring price stability will be higher," reads the statement. It cited the risk of entrenchment in its previous rate-hike announcement, when it raised rates by 50 basis points to 1.5 per cent.

The Bank of Canada says it will continue to complement interest-rate increases with quantitative tightening, a policy meant to reduce its balance sheet over time by halting the bank's purchases of Government of Canada bonds.

The organization's statement did not rule out future rate hikes. “The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank's ongoing assessment of the economy and inflation," it says.

The 2.5 per cent rate is in a neutral range that is assumed to neither stimulate nor slow the economy, according to Josh Nye, Senior Economist, RBC Economics. “Tougher medicine will be needed to get inflation under control," he says.

The Bank of Canada also released its quarterly monetary policy report Wednesday, in which it projects inflation to decline to about three per cent by the end of 2023, and to return to the bank's target of two per cent by 2024. Nye says RBC Economics considers this view optimistic until economic growth slows.

“The BoC admitted the path to such a soft landing has narrowed," says Nye. “In our view, a soft landing will be difficult to achieve and our forecast now assumes a mild recession next year."

The Bank of Canada's next rate decision is scheduled for September 7. Learn more in What Rising Interest Rates Can Mean for Investors.

For the full RBC Economics report, visit rbc.com/economics.