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26 Jan

Bank of Canada maintains policy rate, but sends signal of rate increase

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Posted by: Aneta Zimnicki

The Bank of Canada decided to maintain the overnight rate. This means your variable rate mortgage remains unchanged. However, they presented strong language suggesting the rate will need to be increased.

The Bank has ‘removed its exceptional forward guidance on its policy interest rate’, which means these emergency rates will need to move. ‘Overall economic slack now absorbed’, the Bank is only maintaining its bond buying pace (‘reinvestment phase’). You may now be hearing the term ‘quantitative tightening’ (QT), which means the act of reducing the central bank’s holdings of Canadian government bonds on its balance sheet.

Over the last year, the Bank was stating inflation may be ‘transitory’, stirring many opinions on this assessment. But recently, this language has been dropped entirely from their announcements. The Bank admits inflation now remains well above the target range of 2%, but also expects ‘to decline reasonably quickly’ to about 3% by the end of this year and then gradually ease towards the target over the projection period. However, it bookends the announcement stating ‘The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation.’

In general, interest rate increases are imminent. The Bank has limited policy tools at their disposal, really, so they resort to talking about changes without exercising their tools. Basically raising the rates without raising the rates. They do not want to surprise the market.

Their policy decision is stuck between hot inflation and negative economic impact from the pandemic. Raising rates too quick would also have a negative impact, so they need to carefully execute. The market is fluid, and there are varying assessments on how many rates hikes we will see this year. Some traders are assessing 6 or 7 times this year, that is probably too much to bear realistically. A fairer assessment could be about four hikes this year, equal to maybe 1%, but we will have to see. Equally important is what the US Federal Reserve decides to do, as our economies are very inter-connected. The next Bank of Canada announcement is March 2.