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The question about a likely hike in policy rates is difficult to answer. Two forces that shape the decision of the Bank of Canada are price rise and GDP growth.
The first -- inflation rate -- soared to 3.7 per cent in July 2021, according to Statistics Canada. Data shows that the cost of living is at its highest level in a decade. Shelter costs are up, with prices for upholstered furniture rising over 13 per cent on an annual basis. Vehicle prices are also rising. This is due to a shortage of semiconductor chips. A 5.5 per cent rise in new passenger vehicle prices was observed in July.
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The second -- economic growth -- is a cause of worry. Statistics Canada has lately reported a contraction in the Canadian economy in the second quarter of 2021. A 1.1 per cent contraction was observed on an annual basis. This was in contrast to expectations of a GDP growth of over two per cent.
Also read: Is Canada working on its own CBDC?
Preliminary data by Statistics Canada for July isn’t promising either. It points to a contraction of 0.4 per cent over May 2021.
Near-zero rates in the wake of COVID-19
The Bank of Canada was quick to respond to a likely adverse impact of the COVID-19 pandemic. In March 2020, the Bank announced a second cut to policy rates. The unscheduled cut brought the policy rate to 0.25 per cent.
At the time, the bank cited “minimizing any permanent damage” to the economy as the rationale behind bringing the rate to a near-zero level. Lowering the rate meant encouraging borrowing by individuals and businesses. This could create demand to keep the economy afloat in the wake of restrictions on movement.
Also read: How are low interest rates helping Canada & US?
House prices still very high
The housing market of Canada has remained a cause of worry for policymakers. In May 2021, the Bank’s governor, Tiff Macklem, referred to “high household indebtedness” and “imbalances” in Canada’s housing market as vulnerabilities facing the economy.
Although the housing market is down from the highs observed in March 2021, prices are still very high. An all-time high average price of C$716,828 was seen in March. Since then, both the average price and sales volume have declined. According to the Canadian Real Estate Association (CREA), the House Price Index was up 22 per cent in July on an annual basis.
A rate hike may be in the offing
Economists polled by Reuters are of the view that the BoC is likely to hike the policy rate to 0.50 per cent by the end of 2022. It is also believed that the bank will taper Quantitative Easing (QE).
Although it is not certain that the bank will think of sucking some liquidity from the market in the near-to-medium term, a rise in the number of vaccinated people can act as a trigger. The economy is opening up and new jobs are being added every month.
Bottom line
High inflation in July can prompt the bank to take the recourse of a rate hike. Home prices have long been a cause of concern and low mortgage rates are being blamed for the frenzy. However, the contraction in the second quarter and the delta variant are likely to make the bank re-think on any immediate rate hike.
