Bank of Canada Raises Key Interest Rate to 1.5%

The Bank of Canada on Wednesday increased its key interest rate to 1.5 per cent, marking the second time in a row it has raised its benchmark rate by half a percentage point amid ongoing inflationary pressures.

Canada's central bank also signalled that additional hikes are on the way as inflation remains well above its forecast.

“With the economy in excess demand, and inflation persisting well above target and expected to move higher in the near term, the Governing Council continues to judge that interest rates will need to rise further," the central bank's statement says. The Governing Council is the Bank of Canada's policy-making body.

The Bank of Canada says the “the risk of elevated inflation becoming entrenched has risen," and that it will use its monetary policy tools “to return inflation to target and keep inflation expectations well anchored." It says the policy interest rate remains its core monetary policy instrument, while quantitative tightening (QT) acts as a complementary tool.

In its last rate announcement in April, the central bank announced it would begin QT as of April 25, meaning it would stop purchasing Government of Canada bonds in order to let its balance sheet shrink over time. On Wednesday, it said it will continue its policy of QT.

The Bank of Canada aims to keep inflation at the two per cent midpoint of an inflation-control target range of one to three per cent. Canada's annual inflation rate hit 6.8 per cent in April.

The central bank says the pace of further increases will be guided by its ongoing assessment of the economy and inflation, and it's “prepared to act more forcefully if needed" to meet its commitment to achieve the two per cent inflation target.

“That's not new language for the (Bank of Canada)," says Josh Nye, Senior Economist, RBC Economics, “but it's new to the policy statement." In commentary following the rate decision, Nye says “this hawkish tone reinforces our call for yet another 50 basis point hike in July." He says RBC Economics continues to expect additional hikes of 25 basis points in September and October, resulting in an ultimate key rate of 2.5 per cent.

Nye says the central bank did sound upbeat on current economic conditions.

“Canadian economic activity is strong and the economy is clearly operating in excess demand," says the Bank of Canada. It cites gross domestic product growth of 3.1 per cent, a pickup in wage growth and a moderation in the housing market as positive signals. “With consumer spending in Canada remaining robust and exports anticipated to strengthen, growth in the second quarter is expected to be solid," it says.

The Bank of Canada's next rate decision is scheduled for July 13.

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