Bank of Canada and Reserve Bank of Australia Resume Interest Rate Hikes Amidst High Inflation Concerns

Consumers and investors in Canada have hoped that the nearly half-year break since the last interest rate hike signals a return to a new stage of monetary easing.

The monetary policy committee of the Bank of Canada had a different opinion and resumed the increase of the reference interest rate, against the background of the maintenance of inflation above the target range in the last two years.

The increase of 0.25 percentage points took the monetary policy rate up to 4.75%, the highest level in the last 22 years (see chart 1).

The objective of the Bank of Canada is to maintain inflation at 2% in the medium term, with a variation interval of one percentage point. The increase in the Consumer Price Index exceeded the upper limit in April 2021, at 3.4%, reached a maximum of the last four decades in June 2022, at 8.1%, and the latest official data shows an inflation rate of 4.4 % in April 2023, up from 4.3% in the previous month.

“Monetary policy was not restrictive enough to bring supply and demand into balance and to sustainably return inflation to the 2% target,” the bank’s press release states, justifying its decision by resuming price increases from the residential real estate market, as well as through economic growth beyond expectations, as Bloomberg writes.

The news agency also states that market expectations point to a further increase of 25 basis points at the monetary policy meeting in September 2023.

The Bank of Canada’s decision brought back concerns among investors and consumers, and Finance Minister Chrystia Freeland tried to reassure citizens, according to a Bloomberg report.

“There are a lot of Canadians who are uneasy right now and who will be concerned when they see this step by the Bank of Canada,” Freeland said.

Indeed, Canadians have reason to be worried, given that official data shows that 56% of mortgages granted are with variable interest that adjusts annually.

The Bank of Canada’s decision came only a few days after the announcement of an unexpected interest rate hike in Australia as well.

The increase was also 25 basis points, up to 4.1%, the highest level in the last 11 years (see chart 2).

The increase comes against the backdrop of maintaining inflation well above the target range of 2% – 3% of the central bank, the Reserve Bank of Australia (RBA). The latest official data shows an annual increase in consumer prices of 7% in Q1 2023, after an advance of 7.8% in the previous quarter. Inflation has remained above the upper end of the target range since September 2021.

With a cumulative increase in the policy rate of 4 percentage points over the past 12 months, which may be followed by further increases, the Reserve Bank of Australia hopes to return inflation to the target range by mid-2025, as Bloomberg writes.

James McIntyre, an economist at Bloomberg, said the RBA acted to anchor inflationary expectations, but “the latest increase was unnecessary and risks sending the economy into recession”.

After the unexpected hikes announced in Canada and Australia, the Financial Times wrote that hopes for a rate cut in the US by the end of the year have moderated, especially as the latest data show a robust labor market.

US government bond futures point to a 0.25 percentage point rate hike at the Federal Reserve’s July 2023 policy meeting, after a pause in this month’s meeting, the FT also reported.

“Investors are starting to see a pattern emerging,” as “this week’s moves run counter to the prevailing narrative that central banks are on the verge of pausing rate hikes,” said analyst Jim Reid. at Deutsche Bank.

For Mike Zigmont, head of trading at Harvest Volatility Management, the Bank of Canada’s decision “forces the market to reconsider what the Federal Reserve might do, not necessarily at the next monetary policy meeting, but beyond,” as the Financial Times points out.

While market expectations are gradually returning to further increases in monetary policy interest rates, Danielle DiMartino Booth, former adviser to the president of the Federal Reserve Bank of Dallas, warns that “the bigger surprise will soon be the recognition of the global recession.”

But will such a recession be sufficient to suppress inflationary pressures or will the global economy enter a prolonged stagflation?

And how will the central banks “administer” this phenomenon? Through the simultaneous increase and decrease of interest rates, against the backdrop of the restarting of the printing presses?