After increases in March, April and June, economists predict that the Bank of Canada will raise the key rate by 0.75% on Wednesday, to 2.5%. How far will it take to fight inflation? Opinions differ.
Some economists encourage the institution to continue this progression above 3%. This is the case of Steve Ambler, professor of economics at the School of Management Sciences at UQAM, who advocates an increase of up to 3% in September, then up to 3.5% in January 2023. One of his colleagues on the CD Howe Institute’s Monetary Policy Council, Edward A. Carmichael, even advises going to 4% in July 2023.
“Goods cost more, so there is less purchasing power for Canadians. It also affects their wealth. The real value of their investments is being eroded over time,” recalls Mr. Ambler, justifying the importance of acting against inflation, which reached 7.7% last month.
The economist explains that the increase in the key rate, which guides the interest rates of financial institutions, is intended to lower prices by restricting demand for various products. Consumers will think twice before borrowing a purchase, whether it is a house, a car or household appliances.
“Households with variable rate mortgages will face higher interest payments and limit other expenses,” adds Ambler.
For his part, Hendrix Vachon, senior economist at Desjardins Group, said he expected another increase of 0.25% in September. “In October, we think the Bank of Canada will have enough arguments to take a break and let the economy digest these increases. We hope that would be enough for inflation to begin a downward trend,” says Mr. Vachon.
The latter admits, however, that the scenario could change and that the central bank could continue its rate hikes if inflation does not fall quickly enough.
Not only benefits
For his part, economics professor at Laurentian University Louis-Philippe Rochon does not believe that the increase in the key rate will have the expected effects.
“It won’t solve anything. Rising rates can have an impact on inflation only if the inflation is created by excess demand. But that’s not the case,” he says.
He points out that the current inflation is more the result of international variables such as problems in the supply chain, the war in Ukraine and the price of oil.
At the same time, the rise in rates will “weigh heavily on households that are in debt,” he laments.
Another word is also on everyone’s lips, that of recession. The Royal Bank, in particular, recently predicted a short-lived recession in 2023. Thus, the economic slowdown induced by the drop in consumption could lead to a decline in gross domestic product (GDP) and an increase in unemployment.
Senior economist at the Canadian Center for Policy Alternatives, David Macdonald noted that the rise in the Bank of Canada’s key interest rate has never succeeded in its history in bringing down inflation as much as the institution wishes today. .
“The Bank of Canada’s promise is that it can raise interest rates just enough to reduce inflation, without going overboard and causing a recession. She hopes to find that balance,” says Macdonald.
However, the three times when inflation fell by 5.7%, which would be necessary today to reach the Bank of Canada’s 2% target, i.e. in the 1970s, 1980s and 1990s, the phenomenon been accompanied by recessions and major job losses.
“Is it possible that she will succeed this time?” Yes. But if a pilot told me that he had attempted a landing three times in 60 years and had never succeeded, I would not want to be on board his plane.
Mr. Macdonald believes that the key rate should be stopped at 2.5% and that more targeted measures should be put in place by governments to limit the meteoric rise of certain goods. Among these, he proposes to revise the rules for obtaining mortgage loans to make serial real estate investment less profitable, to exercise rent control and to give the means to the Competition Bureau of Canada to investigate on pricing by large corporations, many of which have seen their profit margins rise since the start of the pandemic.