Odds are increasing that the Bank of Canada will raise interest rates this year, as recent hawkish comments from Governor Tiff Macklem have surprised many observers. The central bank’s stance has shifted amid surging oil prices, which reached US$100 per barrel following geopolitical tensions in Iran.
Hawkish Signals from the Bank
Last week, Macklem warned that interest rates could be adjusted “even if the economy evolves broadly in line” with the bank’s projections. He also noted that “consecutive increases” might be necessary if energy prices continue to rise and remain elevated. This marks a significant departure from earlier expectations that the bank would hold rates steady until 2027.
“At face value, this suggests our view that the bank will wait until 2027 to begin hiking rates is dead in the water,” said Bradley Saunders, North America economist at Capital Economics.
Market Reactions
Financial markets have already adjusted their expectations. Following the bank’s decision to maintain rates last week, bets on rate hikes increased, with markets now pricing in almost two 25-basis-point increases by October. Many economists, however, remain cautious, sticking to forecasts that the bank will keep rates unchanged this year. They acknowledge that the odds of earlier hikes are rising.
Economic Contradictions
Capital Economics argues that a weaker economy may outweigh the threat of inflation, allowing the Bank of Canada to hold off on rate increases. Canada’s GDP returned to growth in February, but early estimates for March indicate flat growth. This suggests that a surge in oil and gas extraction, which supported growth earlier in the year, has since become a drag.
Moreover, a third of consumers surveyed by the bank reported cutting or postponing major spending due to the impact of the Iran war. “Accordingly, we think the bank’s forecast for GDP to rise by 1.5 per cent annualized in both the first and second quarter looks a little punchy,” Saunders noted.
Fiscal Stimulus Doubts
The Bank of Canada may also be overestimating the impact of federal stimulus. The latest monetary policy report cites government spending as a key reason for higher growth this year. However, Ottawa’s fiscal update last week revealed little near-term stimulus beyond previously announced measures. New spending promised in November’s budget focuses on long-term investment.
Trade Risks
Economists also worry that the upcoming review of the Canada-United States Agreement could leave Canada worse off. The central bank’s forecast depends on tariffs remaining at current levels, but trade tensions between the two countries have been escalating.
Growth Forecasts
Capital Economics predicts growth of only 0.9 per cent this year, below the central bank’s forecast of 1.2 per cent. However, skyrocketing oil prices complicate the picture. “$100 per barrel WTI is not to be sniffed at — especially with food prices awkwardly high,” Saunders said. The Bank of Canada faces a delicate balancing act between the risks of a weak economy and runaway inflation.
