With Bank of Canada going Neutral, Recession Bets Climb

The Bank of Canada has signaled that it will increase its interest rates significantly in order to tame the soaring inflation in the country, which increases the risk of an economic recession. But, economists said that this massive rise in interest rates would be worth it if it is able to put a cap on the surging inflation. Last week, Canada’s central bank decided to increase its interest rate from 1.0% to 1.5%, which is the second straight hike of 50 basis points. The bank further noted that it would not hesitate to hike up more in order to bring down inflation that has reached a high of 31 years.

This could mean that there would be further hikes without stopping and these could be larger increases instead of 50 basis points. It is also possible that the end rate might be between the 2% and 3% range, which is considered neutral. This is when interest rates neither slow down or stimulate growth. Economists stated that domestic demand was likely to slow down because of such an assault by the Bank of Canada and this should prevent the rise in inflation to transform into a price spiral. However, experts also said that this balance was delicate and even a slight miscalculation could damage the economy, just as some sectors are recovering like travel.

The worst scenario would be an economic recession in Canada. Market analysts said that risks of recession were quite high because the monetary policy response is very strong in order to cut down inflation. Since the bank needs to take quick action, it makes it difficult for it to be able to gauge the impact of the interest rate increases on the economy. The yield curve in Canada has remained flat, which shows that investors believe the economy will slow down. On Wednesday, the gap between 10 and 2-year bond leads was around 14 basis points.

There has been a sharp cooldown in the housing market, which is considered one of the biggest performers in Canadian economy. After hitting a peak in February, the market has come down because buying power has reduced due to rate hikes. There has also been a 4.9% drop in the export volumes, which has been covered up due to hot commodity prices. Moreover, the inflation rate stands at 6.8% and is scheduled to go higher. Meanwhile, the jobless rate in Canada has reached a record low.

Furthermore, businesses have also reported that the demand is higher than they can meet, which shows that a forceful response is required. Market analysts said that not doing enough would mean that inflation can run free, but doing too much would slowdown the economy. Therefore, the Canadian central bank has to try and achieve the perfect balance. Money markets have predicted that the interest rate will be increased to 3.75% by the end of 2022, which is the highest it has been since 2008. It had started the year with an interest rate of 0.25%.

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