Key rate at 4.5%: tighten your belt, because prices (and inflation) are not about to go down again
On Wednesday, the Bank of Canada announced an eighth consecutive increase in the key rate, which rose from 4.25% to 4.5%. Why increase again when inflation is losing ground? Can we expect prices and interest rates to fall? To find out, we asked all our questions to an economist.
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Why has the policy rate been raised for the 8th time since March 2022?
Everything costs more, both services and consumer goods. Inflation reduces your purchasing power if your income is not growing fast enough. Why then is our central bank continuing to raise its key rate?
“We reached an inflation rate of 8% a few months ago. Today we are around 6%. The problem is, it was very easy to go down from 8% to 6%, but now it’s sticky. It is not decreasing fast enough,” explains Jules Boudreau, economist at Mackenzie Investments.
This can be explained, among other things, by the context of full employment. Inflation tends to rise when unemployment is low and tends to fall when unemployment is high. “Labour markets are still tight: the unemployment rate is near historic lows and businesses say they continue to have difficulty finding staff,” reads the Bank’s statement.
It’s not rocket science: the stronger the employment, the more people consume and the more the demand for goods and services is stimulated. On the other hand, this demand must decrease to allow inflation to slow down.
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When could the target inflation rate be reached?
The one and only mandate of the Bank of Canada is to maintain the inflation rate around the target rate of 2%. This is why it has continued to raise the key rate every two months since March 2022, with a view to reaching this target.
For its part, the central bank stipulates that “as the effects of interest rate hikes continue to reverberate through the economy, spending on consumer services and business investment should slow”.
It is this slowdown in the economy that should allow supply to catch up with demand and therefore reach the 2% inflation target. According to the Bank of Canada, inflation, as measured by the consumer price index, is expected “to settle around 3% at mid-year and return to the 2% target in 2024”.
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Will prices eventually come back down?
No. At least, not unless there is a major recession in 2023, says economist Jules Boudreau.
“Prices themselves will not come down. They hit a plateau. On the other hand, inflation, which is at the origin of the growth in prices, is in the process of coming down, ”he nuances.
There is therefore no deflation on the horizon, ie the opposite phenomenon of inflation.
The expression “what goes up eventually comes down” may be true for interest rates, but it is not for consumer prices, which are implanted in the economy for Well.
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When will we see a decline in interest rates?
Not before the end of 2023, estimates the economist.
“Several economists believe that there will be a pivot very soon and that variable rates will return to around 3% within six months, but we [Placements Mackenzie], we don’t believe it. We believe that rates will remain above 4% throughout 2023,” says Jules Boudreau.
For first-time buyers, this is a particularly painful situation. Home prices began to fall at the end of 2022, but interest rates remain very high, which complicates access to property.
Nevertheless, the economist suggests that buyers prefer a fixed rate to a variable rate, since the rise in rates is not over.
“Rates will go up again today and maybe in the future. It is still advantageous to lock in a rate for the next few months.”
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What can you do with your investments?
It is true that the ups and downs of the stock markets have placed investors in uncomfortable situations for several months, but nothing is lost for people who invest sums for the long term, ie with a horizon of more than 5 years.
“For young investors, this is a golden opportunity to take risk, says Jules Boudreau. I don’t think it’s a good idea to pull out of the markets now, because strong returns are expected in the future.”
Can we expect more key rate hikes?
Yes. It would not be surprising if the Central Bank proceeded with a ninth consecutive hike on March 8th.
“The worst of inflation is behind us, but to get a target rate of 2%, it takes work and it will not happen overnight.”