Bank of Canada Slows Pace of Rate Hikes Amid Recession Fears, Raising Questions on Fed’s Next Move

The Bank of Canada is framed through fall foliage as colours peak in Ottawa, on Oct. 19, 2022. Sean Kilpatrick/The Canadian Press

The Bank of Canada (BoC) has decided to slow its pace of rate hikes amid fears of a major global recession.

BoC Governor Tiff Macklem announced on Oct. 26, that the central bank would raise benchmark interest rates by 50 basis points to 3.75 percent on to combat inflation, for the smallest increase since June.

This was lower than the 75 basis point hike predicted by most economists, after the central bank increased rates by the same amount last month and a record full percentage point in July.

Since March, policymakers have raised interest rates by 3.5 percentage points, in a hawkish attempt to control rising prices by raising borrowing costs to curb spending.

The central bank’s surprising move has once again raised questions about its willingness to further cool the Canadian economy, as well as the path taken by the Federal Reserve, which is expected to announce another round of policy rate hikes the following week.

The BoC, which has been viewed by some as a “leading indicator” for the Fed, may be finally taking a divergent path from its peers to the south.

Balancing Interest Rate Hike and Slowing Price Growth

Earlier this month, the Reserve Bank of Australia (RBA) announced a similar deceleration in rate hikes.

Like his Australian colleagues, Macklem and his colleagues may be trying to avoid pushing Canada into a technical recession, due to the risks associated with higher interest rates.

The BoC’s separately released Monetary Policy Report, which details quarterly forecasts, raised the likelihood of a technical recession, highlighting growling “financial stresses” worldwide.

The revised forecasts are predicting a slowdown and a possible contraction in Canadian GDP in the next several months, as tighter global monetary policies begin to weigh on economic activity.

Canadian GDP is expected to fall by half to 0.9 percent next year, with economic growth slowing to an annualized 0.5 percent pace for the current quarter.

“A couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth,” noted the report.

Bank officials are optimistically expecting that inflation will tumble below 3 percent by the end of 2023, which is close enough to meet the bank’s goal of 2 percent inflation.

However, policymakers also report that there is currently no “meaningful evidence” of any sign of easing in inflationary pressures, which stubbornly remains high.

Consumer demand still remains high in Canada, but the effects of higher interest rates are starting to become evident price sensitive areas, according to the BoC press release.

“Economic growth is expected to stall through the end of this year and the first half of next year as the effects of higher interest rates spread.”

The bank governor and his team also pointed to the strength of the U.S. dollar as a driver behind global inflation.

Only Slight Change in Official Central Bank Policy

Despite a change in strategy, members of the board said they will continue to raise rates over the coming months, but at a slower pace, while maintaining the same stance against inflation.

The optimal peak interest rate for next year still remains at about 4.5 percent.

“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 inflationary expectations are responding,” stated central bank authorities.

“We are resolute in our commitment to restore price stability for Canadians and will continue to take action as required to achieve the 2% inflation target.”

Policymakers in Australia and Canada have been worried about the impact of a hawkish policy on struggling households, by easing the rate of increases.

The RBA ended its series of consecutive 50 basis point hikes, instead only raising the borrowing rate by 25 basis points to 2.6 percent on Oct. 4.

“The arguments for continuing with an increase of 50 basis points stemmed from the inflationary environment and risks to inflation expectations,” according to the RBA’s meeting minutes.

“A smaller increase than that agreed at preceding meetings was warranted given that the cash rate had been increased substantially in a short period of time and the full effect of that increase lay ahead.”

A general view of the Reserve Bank of Australia building in Sydney, Australia, on May 3, 2022. Brook Mitchell/Getty Images

Board members noted that they needed to “assess the effects of the significant increases in interest rates to date and the evolving economic outlook.”

Politics and Interest Rates

Macklem, like his American colleague, Jerome Powell, has been on the receiving end of heavy criticism across the political spectrum in Canada.

Some hawks in Canada are concerned that a divergence from the Fed, may risk weakening the Canadian dollar and hurt the economy with a spike in import prices and already high fuel costs.

Meanwhile, the latest news from Canada has further fueled debates over monetary policy in Washington.

Democrats are worried about the impact of the Fed’s policies right before the U.S. midterm elections on Nov. 8, as they try to retain control of Congress.

Sen. Sherrod Brown (D-Ohio), chair of the U.S. Senate banking committee, requested that Powell and his colleagues avoid antagonizing the labor market in their attempt to control rising prices, reported Bloomberg.

“We must avoid having our short-term advances and strong labor market overwhelmed by the consequences of aggressive monetary actions to decrease inflation, especially when the Fed’s actions do not address its main drivers,” Brown, wrote to Powell.

“For working Americans who already feel the crush of inflation, job losses will make it much worse. We can’t risk the livelihoods of millions of Americans who can’t afford it.

“I ask that you don’t forget your responsibility to promote maximum employment and that the decisions you make at the next FOMC meeting reflect your commitment to the dual mandate,” Brown continued.

The next Fed policy rate meeting is on Nov. 1-2, a week before the midterms.