Bank of Canada Raises Rates, Declares Pause to Assess Economic Impact

Canada’s main interest rate increases to 4.50%, the highest level in over 15 years

OTTAWA—The Bank of Canada raised interest rates on Wednesday by a quarter point and said it would now pause to assess the economic impact from sharply higher borrowing costs.

The Bank of Canada increased its target for the overnight rate to 4.50% from 4.25%, or the highest level in over 15 years. More important, the Bank of Canada is one of the first central banks among major developed-world economies to declare that it is done for now raising interest rates in the quest to bring inflation down from historically high levels. Central banks are trying to balance the risks between raising rates too aggressively and triggering a deep recession, and raising rates at too tepid a pace and allowing inflation expectations to remain elevated.

In the course of about 10 months, interest rates in Canada have climbed 4.25 percentage points. Meanwhile, the housing market, which helped power the recovery from the pandemic-fueled recession, weakened markedly. The Bank of Canada’s most-recent quarterly survey of companies indicated business confidence declined to its lowest level in over two years, and about a third of Canadian firms expected sales to decline over the next 12 months. Canada’s consumer-price index has cooled from a peak of 8.1% in June to a recent reading in December of 6.3%, and the Bank of Canada said inflation is projected to “come down significantly” in 2023.

“We have raised rates rapidly, and now it’s time to pause and assess whether monetary policy is sufficiently restrictive to bring inflation back to the 2% [inflation] target,” Bank of Canada Gov. Tiff Macklem said at a press conference in the Canadian capital. “Given the speed and magnitude of the interest-rate increases over the last year, their full effect is still to come.”

Mr. Macklem said the central bank will hold interest rates at its current level for now, so long as economic activity evolves in line with its latest forecast. “If we need to do more to get inflation to the 2% target, we will,” he said, about the prospect of further rate increases.

Later this month, Federal Reserve officials begin deliberations before a Feb. 1 policy announcement, at which time the Fed is expected to slow the pace of rate increases for a second straight meeting. In December, the Fed raised the benchmark federal-funds rate by a half point to a range between 4.25% and 4.5%.

Twelve of 13 economists surveyed last week by The Wall Street Journal said they expected Canada’s central bank to lift its main interest rate by a quarter point. Economists said Wednesday explicit guidance on pausing rates was a surprise, although they remain convinced the latest quarter-point increase to 4.50% is likely the last. “All this presents a high barrier for further interest rate hikes,” said Stephen Brown, an economist at forecasting firm Capital Economics.

Mr. Brown and other analysts say Canada’s relatively high consumer debt levels and the economy’s sizable exposure to housing leaves the economy vulnerable after a rapid escalation in rates.

Economists at TD Securities said talk in the financial markets likely turns to the timing of the Bank of Canada’s first rate cut, although the firm said such a scenario won’t unfold until inflation is below 3% and growth is “demonstrably below” 2%. Mr. Macklem said at the press conference it was “far too early” to discuss rate relief.

According to the Bank of Canada’s outlook, inflation is expected to reach 3.5% in the second quarter, citing lower energy prices, improvements in the supply-chain network and the impact of higher rates on consumption in Canada and abroad. The Bank of Canada said it anticipates reaching its 2% inflation target in 2024. Short-term gauges of core prices, which strip out volatile items like food and fuel, have eased.

“We are turning the corner on inflation,” Mr. Macklem said. “Momentum is cooling.” The central bank, though, identified upward risks to its inflation outlook, most notably the sudden reopening of China’s economy and the possible impact on energy prices.

The central bank said a rate increase, to 4.50%, was warranted because recent growth data was stronger than anticipated and the labor market remained tight, with the unemployment rate near historic lows and businesses reporting difficulties finding workers. “Our overheated economy did not cool as much as we expected,” Mr. Macklem said.

Growth in 2022 likely hit 3.6%, slightly higher than its previous quarterly forecast. Final data covering gross domestic product in 2022 is scheduled for release in late February. In the central bank’s rate-policy statement, it said “there is growing evidence that restrictive monetary policy is slowing activity, especially household spending.”

In an accompanying forecast, the central bank said mortgage interest payments as a share of after-tax income have climbed to 4.5% at the start of 2023, from 3.2% a year ago, and expects that level to increase further as homeowners renew their mortgages at higher rates.

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