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The Bank of Canada hikes interest rates to 0.50%, the first increase since 2018, as it warns about higher inflation and a “major new source of uncertainty” related to Russia’s invasion of Ukraine. Anthony Okolie speaks with James Orlando, Senior Economist, TD Bank, about the central bank’s efforts to tame rising prices.
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- The Bank of Canada hiked rates 25 basis points this morning. That's the first time rates have moved higher since 2018. James, what's your take on the move?
- Thanks, Anthony. It's one of those moves that everyone was expecting. We were waiting for it for quite a bit of time now. It's very much a needed rate hike, given where the employment situation is. Yes, we had a little bit of a dent from the Omicron wave in Canada, but we expect employment to be bouncing back very strongly.
Inflation is above 5% in Canada. From our view, this rate hike and more rate hikes are probably going to be necessary to be able to cool some of this inflationary pressure that we have built up in Canada.
- OK, so you said that more rate hikes are necessary. How many rate hikes do you expect this year, and where will that leave rates at the end of 2022?
- Yeah, absolutely. So what we're looking at is for a series of rate hikes to happen at the upcoming meetings. So this really-- this rate hike today really set that in motion. What that would do, it would bring the policy rate to about 1.5% by the end of 2022. We expect that rate to finally top out around 175 in early 2023. And what this is going to do-- the intention is to hopefully bring down some of the inflation that we're seeing right now. So it's the Bank of Canada really catching up to what's happened in the overall economy.
- Now, it's notable-- the Bank of Canada did highlight the Russia-Ukraine invasion as a major source of uncertainty for the economy. How does that factor into their policy-making decisions going forward?
- Yeah, so the Bank of Canada highlighted this, the Russia-Ukraine conflict, really early on in their statement. They're saying that it's-- like we all know, is that the direction of which way this goes is very uncertain. Nobody knows. And because of that, we don't really know what the economic impact is going to be. We don't know what the financial market impact is going to be.
If it's one of those situations where things get much worse, where we see financial conditions tighten, so equity markets fall further. We start seeing bond and bond yields rise, like credit yields rise. Interbank markets tighten up. That is a tightening in financial conditions. Now, it would be a little bit strange if that happens and the Bank of Canada continues its policy rate hikes because policy rate hikes are also tightening in financial conditions.
So, if things get worse, it would likely cause potentially a pause, a delay in the rate hikes for the Bank of Canada. So that's sort of the thing that we're watching out for, and it's very clear the Bank of Canada is watching out for the same thing too.
- OK, so given the outlook for rates, do you think that will be enough to tamp down on inflation, or do you see inflation as being here to stay?
- Well, so we think that inflation is going to remain elevated for quite some time right now. We're at 5% right now. The fear is that this inflation right now becomes more entrenched in society. So you start seeing it through higher wages, through more bargaining power, through whatever it is that's going to be keep the spiral going. We're seeing it in just in so many broad ways right now. Food price inflation is definitely one of the things that is very on top of mind for Canadians right now.
So what we're saying is that, as rates go up, what that does is it reduces a little bit of that demand pressure that's causing inflation. But there's still a lot of supply issues that are going to be remaining for a while. So yes, the Bank of Canada interest rate hikes, not to mention the Federal Reserve's hike in interest rates as well, this will impact inflation, hopefully limiting the upside that we're seeing right now. So hopefully, seeing a peak in inflation, but not necessarily bringing inflation back down to 2% percent right away.
And honestly, the Russia-Ukraine conflict right now is really only going to exacerbate some of these inflationary problems right now. Whether it be higher price of energy, higher prices of food. Russia is a big producer of oil, natural gas. It's very much a very strong narrative that we're seeing right now. Where yes, interest rates should have an impact, but there's so many other factors going on that is likely going to keep inflation higher in Canada than what Canada otherwise wants.
- Yeah. Certainly, there is a lot going on. What's your outlook on the loonie? How do you expect it to perform going forward?
- Yeah, so the loonie is-- you know, most Canadians are really surprised that the loonie is trading between like $0.78, $0.79 US cents right now, given the fact that we have oil prices so high. Usually, you put that-- you put the loonie on a graph with oil, and they're moving in lockstep with one another.
I think the loonie right now is suffering a little bit from the risk off sentiment we're seeing right now, so we're seeing equity markets- they're well off their peaks from early 2022. Not to mention the fact that the Bank of Canada was in a situation where it was thought to be leading the Federal Reserve, with respect to interest rate hikes. But now the Federal Reserve in the middle of March is going to be following Bank of Canada's lead, hiking interest rates, hiking interest rates in probably in the same clip as the Bank of Canada, but potentially even getting to a higher level of rates, given the fact that inflation is so much higher in the US than it is in Canada.
So all these factors are sort of playing out for the loonie right now, and it's been a really tough grind for the loonie to move higher. That said, if things resolve themselves between Russia and Ukraine, some of the geopolitical conflict is reduced. That risk discount that's happening for the Canadian dollar might come off. You might see a little bit higher loonie going forward.
- James, thank you very much for your time.
- Thank you.
[MUSIC PLAYING]
- Thanks, Anthony. It's one of those moves that everyone was expecting. We were waiting for it for quite a bit of time now. It's very much a needed rate hike, given where the employment situation is. Yes, we had a little bit of a dent from the Omicron wave in Canada, but we expect employment to be bouncing back very strongly.
Inflation is above 5% in Canada. From our view, this rate hike and more rate hikes are probably going to be necessary to be able to cool some of this inflationary pressure that we have built up in Canada.
- OK, so you said that more rate hikes are necessary. How many rate hikes do you expect this year, and where will that leave rates at the end of 2022?
- Yeah, absolutely. So what we're looking at is for a series of rate hikes to happen at the upcoming meetings. So this really-- this rate hike today really set that in motion. What that would do, it would bring the policy rate to about 1.5% by the end of 2022. We expect that rate to finally top out around 175 in early 2023. And what this is going to do-- the intention is to hopefully bring down some of the inflation that we're seeing right now. So it's the Bank of Canada really catching up to what's happened in the overall economy.
- Now, it's notable-- the Bank of Canada did highlight the Russia-Ukraine invasion as a major source of uncertainty for the economy. How does that factor into their policy-making decisions going forward?
- Yeah, so the Bank of Canada highlighted this, the Russia-Ukraine conflict, really early on in their statement. They're saying that it's-- like we all know, is that the direction of which way this goes is very uncertain. Nobody knows. And because of that, we don't really know what the economic impact is going to be. We don't know what the financial market impact is going to be.
If it's one of those situations where things get much worse, where we see financial conditions tighten, so equity markets fall further. We start seeing bond and bond yields rise, like credit yields rise. Interbank markets tighten up. That is a tightening in financial conditions. Now, it would be a little bit strange if that happens and the Bank of Canada continues its policy rate hikes because policy rate hikes are also tightening in financial conditions.
So, if things get worse, it would likely cause potentially a pause, a delay in the rate hikes for the Bank of Canada. So that's sort of the thing that we're watching out for, and it's very clear the Bank of Canada is watching out for the same thing too.
- OK, so given the outlook for rates, do you think that will be enough to tamp down on inflation, or do you see inflation as being here to stay?
- Well, so we think that inflation is going to remain elevated for quite some time right now. We're at 5% right now. The fear is that this inflation right now becomes more entrenched in society. So you start seeing it through higher wages, through more bargaining power, through whatever it is that's going to be keep the spiral going. We're seeing it in just in so many broad ways right now. Food price inflation is definitely one of the things that is very on top of mind for Canadians right now.
So what we're saying is that, as rates go up, what that does is it reduces a little bit of that demand pressure that's causing inflation. But there's still a lot of supply issues that are going to be remaining for a while. So yes, the Bank of Canada interest rate hikes, not to mention the Federal Reserve's hike in interest rates as well, this will impact inflation, hopefully limiting the upside that we're seeing right now. So hopefully, seeing a peak in inflation, but not necessarily bringing inflation back down to 2% percent right away.
And honestly, the Russia-Ukraine conflict right now is really only going to exacerbate some of these inflationary problems right now. Whether it be higher price of energy, higher prices of food. Russia is a big producer of oil, natural gas. It's very much a very strong narrative that we're seeing right now. Where yes, interest rates should have an impact, but there's so many other factors going on that is likely going to keep inflation higher in Canada than what Canada otherwise wants.
- Yeah. Certainly, there is a lot going on. What's your outlook on the loonie? How do you expect it to perform going forward?
- Yeah, so the loonie is-- you know, most Canadians are really surprised that the loonie is trading between like $0.78, $0.79 US cents right now, given the fact that we have oil prices so high. Usually, you put that-- you put the loonie on a graph with oil, and they're moving in lockstep with one another.
I think the loonie right now is suffering a little bit from the risk off sentiment we're seeing right now, so we're seeing equity markets- they're well off their peaks from early 2022. Not to mention the fact that the Bank of Canada was in a situation where it was thought to be leading the Federal Reserve, with respect to interest rate hikes. But now the Federal Reserve in the middle of March is going to be following Bank of Canada's lead, hiking interest rates, hiking interest rates in probably in the same clip as the Bank of Canada, but potentially even getting to a higher level of rates, given the fact that inflation is so much higher in the US than it is in Canada.
So all these factors are sort of playing out for the loonie right now, and it's been a really tough grind for the loonie to move higher. That said, if things resolve themselves between Russia and Ukraine, some of the geopolitical conflict is reduced. That risk discount that's happening for the Canadian dollar might come off. You might see a little bit higher loonie going forward.
- James, thank you very much for your time.
- Thank you.
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