The Bank of Canada may not raise interest rates as much as many fear

An economist says interest rates could peak half a point lower than the market expects due to rising Canadian household debt

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The Bank of Canada’s “hard-line” statement this month and the inflation shock in the US prompted many investors and economists to raise their interest rate expectations.

The sudden strength of the core consumer price index in the United States last week turbulent markets and raised expectations that the US Federal Reserve rate will reach nearly 4.5 percent by next April.

Markets are now betting that the Bank of Canada will raise its policy rate to a peak of 4.1 per cent by next March, said Paul Ashworth, chief North American economist at Capital Economics, about 50 basis points higher than it was a month ago.

Among the major Canadian banks, the Royal Bank of Canada and Toronto-Dominion Bank now expect the Canadian interest rate to peak at 4 per cent, and Imperial Bank of Canada has raised its forecast to 3.75 per cent. Bank of Nova Scotia and Bank of Montreal are also forecasting a 3.75 percent rise.

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But Capital argues that there are many reasons why the central bank may not raise what many now assume.

First, a cloudy view of manufacturing. Although manufacturing sales increased 0.5 percent in June and 0.6 percent in July, those gains partially offset a 2.1 percent decline in May.

July’s gain also appears to have been boosted by a temporary rise in auto and parts sales, due to fewer retool shutdowns. Ashworth said US data showed a similar rise, but then revised down and production in August fell 1.4 percent “suggesting that the Canadian increase will also prove to be fleeting.”

“With manufacturing PMIs down sharply over the past two months, it appears that global manufacturing distress – caused by zero-lockdowns in China and higher energy prices in Europe – will hit Canada as well,” he said.

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Then, Canadian household wealth plunged in the second quarter in the biggest quarterly drop ever, as both the housing market and stock markets lost steam.

In one quarter, Canadians lost a record $990 billion in net worth. During the 2008 financial crisis, net worth declined by just $520 billion over 12 months.

This would be even more alarming, Ashworth said, for the vast store of wealth that Canadians have accumulated during the pandemic years; Net worth is still much higher than it was before the pandemic. And it will decline further as housing wealth continues to decline over the coming quarters.

The biggest reason, though, that Capital expects the Bank of Canada’s peak rate to be lower than the Fed’s is increased household debt. As borrowing rates rose, Canadian household credit market debt rose to a record high of 182 percent of disposable income.

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“With household debt on the rise, and now a significantly weaker labor market, we expect the peak Canadian policy rate to be closer to 3.5 percent,” Ashworth said.

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  • Prime Minister Justin Trudeau will attend the opening of the high-level general debate of the 77th session of the United Nations General Assembly. Foreign Minister Melanie Jolie will also attend
  • Trudeau will also participate in the World Food Security Summit and “Countdown to COP15: The Outstanding Leaders Event for a Nature Positive World”. The Minister of Environment and Climate Change, Stephen Gilbolt, will also be present
  • Bank of Canada Deputy Governor Paul Baudry delivers a speech titled “Pandemic Macroeconomics: What We’ve Learned, and What May Away in the Future”
  • Officials from Finance Canada, Health Canada, the Canadian Mortgage and Housing Corporation, and the Canada Revenue Agency will hold a technical briefing on the implementation of the recently announced Dental Credit, Housing and Goods and Services Tax (GST) affordability measures.
  • The Competition Bureau will host the Competition and Green Growth Summit, where experts will discuss the interaction between competition law and policy and sustainability. The summit will bring together international competition authorities, regulators, companies, NGOs, lawyers and academics
  • The Natural Resources Permanent Committee is holding a meeting on the greenhouse gas emissions cap for the oil and gas sector
  • Elevate Festival Tech Conference in Toronto
  • Canadian Mining Association President and CEO, Pierre Gratton, delivers the keynote address at the Vancouver Board of Trade Forum on Mining
  • Today’s data: Canadian CPI, Teranet/National Bank Home Price Index, and Job Vacancies; Starting housing and building permits in the United States
  • gains: Aurora Hemp

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Canada Inflation Releases Today After the shock to the markets last week, when US inflation rose rather than decreased, it would be understandable for some to be cautious. Most data is expected to show general inflation slowed slightly in August, but RBC economists say “under the weak headline figure, some prices are still rising.” They expect inflation excluding food and energy to remain steady at 5.5 per cent and not to peak until later this year when the Bank of Canada rate hikes actually begin.

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Today’s Posthaste wrote by Pamela Heavin (Tweet embed), with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

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