Beyond neutral

In line with market expectations (though not this blogger's; mea culpa), the Bank of Canada raised official interest rates by 75 basis points today. The overnight rate target is now 3.25 percent, just above the 2.5-3.0 percent rate the Bank (and markets) consider to be "neutral".  The generally hawkish tone of the press release suggests there are more hikes to come.  

That press release notes that the domestic economy remains strong, though there are signs that things may slow down in the second half of this year as the impact of policy tightening starts to be felt:

The Canadian economy continues to operate in excess demand and labour markets remain tight. Canada’s GDP grew by 3.3% in the second quarter. While this was somewhat weaker than the Bank had projected, indicators of domestic demand were very strong – consumption grew by about 9½% and business investment was up by close to 12%. With higher mortgage rates, the housing market is pulling back as anticipated, following unsustainable growth during the pandemic. The Bank continues to expect the economy to moderate in the second half of this year, as global demand weakens and tighter monetary policy here in Canada begins to bring demand more in line with supply.

As for inflation, the Bank sees little reason for optimism in the near term, and continues to fret about the risk that expectations of persistently high inflation may become entrenched:

CPI inflation eased in July to 7.6% from 8.1% because of a drop in gasoline prices.  However, inflation excluding gasoline increased and data indicate a further broadening of price pressures, particularly in services. The Bank’s core measures of inflation continued to move up, ranging from 5% to 5.5% in July. Surveys suggest that short-term inflation expectations remain high. The longer this continues, the greater the risk that elevated inflation becomes entrenched.

One development that may be causing heightened concern for the Bank is the way Canadian households are dealing with the rising cost of living. Surprise, surprise, they are borrowing more. A new report from TransUnion Canada shows that consumer debt in Q2 stood 9.2 percent higher than a year earlier and 16 percent higher than before the pandemic.  Although delinquency rates remain low, this must be expected to change as higher rate begin to bite. Forget the political squabbling over the state of public finances: it is the financial health of the household sector that currently poses the greater threat to Canada's financial stability, given debt levels and the abrupt correction in the housing market. 

At the conclusion of the press release, the Bank's Governing Council still judges that the policy interest rate will need to rise further. However, it is reasonable to surmise that the phase of outsize rate hikes is at an end. After a disastrously late start, the Bank has now raised rates by 300 basis points in little more than half a year. A reversion to more customary 25 basis point increments is now in the cards, and if the bite on household finances continues to worsen, we may soon be at the end of this tightening cycle.