The Bank of Canada could raise its key rate to 3.0%

bank of canada
bank of canada

The Bank of Canada’s key rate could reach 3% by the end of the year. An increase of 75 basis points is not excluded by the central bank, which seeks to prevent an inflationary spiral from taking hold of the Canadian economy.

We certainly think that it is necessary to go towards the top of the range of 2 to 3%, said the Deputy Governor of the Bank of Canada, Paul Beaudry, to Economic Zone. The bank assesses its neutral rate between 2 and 3%. The current rate is at 1.5%, after rising 50 basis points on Wednesday.

To get there quickly, the central bank is not ruling out raising its key rate by 75 basis points in July. It’s possible, says Paul Beaudry.

It’s not something we decided to do, but we will consider it if necessary. There again, it depends somewhat on developments in the economy. If we see inflation continue to rise, if we continue to see this overheating of the economy, we might consider that. We want to have all these possibilities, for people to understand that these are possibilities that can happen, depending on economic developments in Canada.

The Bank of Canada’s next decision is scheduled for July 13. Mistakes have been made
While inflation has consistently exceeded its forecasts over the past year, the Bank of Canada now acknowledges that it made mistakes in its assessment of the cost of living. In his speech, Paul Beaudry said that the institution will present an initial analysis of the mistakes we made in our inflation forecasts in July.

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Certainly, we recognize that we have made mistakes, declared Paul Beaudry to Economic Zone. It’s a very difficult time to predict inflation. Much of the inflation is dominated by the price of oil, the price of certain foods, and the prices of commodities. These are all very difficult things to predict. We are already trying to learn from our mistakes.

He identifies three reasons for the poor assessment of the Bank of Canada. First, the bank expected that supply disturbances, which are of external origin, would be temporary, as is often the case. Then, for much of 2021, the economy was running slower than its potential capacity. Then the bank worried about the impact of a premature tightening on people who had lost their jobs during the pandemic. With the health and economic rules still partially in force, it was difficult, according to Paul Beaudry, to make a change to monetary policy.

“ The risk we were managing was that high inflation would end up influencing expectations and starting to take root if it lasted longer than expected. It seemed reasonable to take that risk at the time, given that there was excess capacity in the economy and it was thought that the supply-side sources of high inflation were likely to be temporary.” – A quote from Paul Beaudry, Deputy Governor of the Bank of Canada

Today, demand is now considered to be excess. And the supply remains disrupted by the problems in the supply chains, the war, and the confinements as well. As a result, there is now a greater risk that inflation expectations will become unanchored and that high inflation will take hold. And it is here that the bank says it must act firmly. We will not let this high inflation take root, declared Paul Beaudry.

Inflation takes root when it feeds on itself. Prices go up because other prices go up too, and because the cost of labor goes up. This cost rises because workers want to be able to afford the higher prices for goods and services. No continuous external forces, such as supply disruptions or firming demand, are needed to fuel this type of inflation. It comes to rise almost on its own, largely because people expect it to stay high or keep rising.

Paul Beaudry recalls that the Bank of Canada intervened massively to support the economy during the pandemic by buying government bonds. The bank’s balance sheet reached $575 billion in 2021. It is now at $465 billion and the institution expects to reach about $280 billion by the end of 2023.

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