UPDATED: Bank of Canada raises key interest rate by 0.75%, says rates likely need to go higher

economy

The Bank of Canada raised its key interest rate by three-quarters of a percentage point Wednesday and signalled this won't be the last increase as it continues its battle against high inflation.

The rate hike was in line with what many economists were expecting and brings the bank's key rate target to 3.25 per cent.

In the rate announcement, the Bank of Canada says global inflation remains high because of global supply chain disruptions, the effects of COVID-19 and the war in Ukraine.

Domestically, the bank says the economy continues to operate in "excess demand."

The move Wednesday is the fifth consecutive interest rate increase this year, pushing the bank's key rate above what it calls the "neutral range" between two and three per cent.

The Bank of Canada, along with central banks around the world, has been raising interest rates in an effort to cool sky-high inflation after slashing its key rate to near-zero at the start of the pandemic.

Inflation moved higher in the first place in part because central banks around the world were engaging in stimulative policies at the onset of the pandemic, said William Robson, CEO of the C.D. Howe Institute. Now, as they act in unison to quash inflation, the risk is on the other end.

"All of the central banks now are moving to be more restrictive," said Robson. "If economies everywhere start to soften a lot at the same time, then that to my mind sort of amplifies the risk that we could have a recession."

CIBC, which was previously predicting Wednesday's rate hike would be the last one of the year, is now adjusting their forecast to account for another rate hike in October.

"The BoC appears ready to sacrifice more growth than we expected to get inflation falling on a faster trajectory," said CIBC chief economist Avery Shenfeld in a note.

The increase will feed into other lending rates, making it more expensive for Canadians and businesses to borrow money.

Canada's year-over-year inflation rate was 7.6 per cent in July, easing from 8.1 per cent in June as gas prices fell.

However, the bank says its core measures of inflation, which tend to be less volatile, continues to move up while short-term inflation expectations remain high.

"The longer this continues, the greater the risk that elevated inflation becomes entrenched," the Bank of Canada said in its press release.

Central banks tend to worry when people and businesses expect inflation to remain high because it can lead to a self-fulfilling prophecy: businesses set future prices higher, while workers negotiate future wage increases to match up with their expectations of inflation.

While debate has been bubbling about whether this will be the last interest rate hike of the year, the Bank of Canada was clear that more increases may be needed to bring inflation down to its two per cent target.

"Given the outlook for inflation, the governing council still judges that the policy interest rate will need to rise further," the bank said in its announcement.

"As the effects of tighter monetary policy works through the economy, we will be assessing how much higher interest rates need to go to return inflation to target."

The Bank of Canada expects the economy to slow in the second half of this year as global demand weakens and higher interest rates dampen economic activity domestically.

The bank says it is complementing interest rate hikes with the continuation of quantitative tightening.