Bank of Canada Warns Rates May Climb Even Higher Than “Neutral”

High inflation has become such a risk to the economy, the central bank will do anything to slow it. That might include raising interest rates higher than already aggressive forecasts have called. This was the message from the Bank of Canada (BoC) at the Standing Committee on Finance today. The central bank Governor made it clear they will act “forcefully” to control inflation, which won’t be coming down by itself. That can mean much higher mortgage rates than forecast. 

What Is A Neutral Policy Rate?

The neutral policy rate is the short-term interest rate where output and inflation are stable. When the overnight rate is below this point, it’s expansionary and helps to stimulate demand for goods and drive inflation. Above the neutral policy rate and the central bank is placing a drag on demand to help achieve the target rate of inflation. 

What is the actual number for the neutral rate? That’s a little more difficult to pin down, but the BoC raised its forecast to a range of 2.00% to 3.00% back in December. Prior to December, it was forecast between 1.75% and 2.75%. The delay in tackling inflation helped the neutral rate climb higher. 

Canada May Need Rates Above Neutral To Cool Inflation

The BoC suddenly changed its tune on transitory inflation that will resolve on its own. For the second time this year, the central bank said they will “forcefully” tackle high inflation if needed. Governor Macklem also emphasized the central bank had an inflation target to maintain, not one for interest rates. 

No upper bound for interest rates is important to understand, since the BoC can go above the neutral policy rate to control inflation. At least for a brief period. 

“…we may need to take rates modestly above neutral for a period to bring demand and supply back into balance and inflation back to target,” said Governor Macklem in his opening remarks. 

Similarly, if inflation is cooling faster than expected, they said they would pause hikes. With the central bank warning “excess demand” is a big issue, a strong negative shock would need to appear before that becomes an option. Though anything is possible in the “new normal,” so don’t totally discount the idea. 

What does this mean? Ultimately, interest rates (and mortgages) can go even higher than previously thought. Most forecasts are based on the BoC achieving the neutral rate, which many forecasts assume will be hit this year. If the central bank needs to go above the neutral policy rate, the aggressive forecast from banks like Scotiabank would seem quite tame in comparison. 

11 Comments

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  • Axel McLion 8 months ago

    I wonder if the powers that be want more of the status quo (inflation, talk about raising rates to scare market rather than do it) or if they want to switch course and allow some deflation to bankrupt the masses who are betting on the former….

  • john 8 months ago

    They will continue to lie and inflate……………it is the only way they have of lowering the debt they have created

  • Alan 7 months ago

    Inflation with low interest rates are good for the rich because they get cheap loans to become richer with stonks, doggy coins and homes for DINK couples and their pet dogs, while the working class have their earings and purchasing power eroded.

    It’s about time to hike rates to cool inflation. Simple economics.

  • Watching for real estate bubble to deflate. 7 months ago

    Hey check out Zolo. (if you’re interested)

    A lot of new properties have been put up for sale this week and last week. Several prices end in “888” to attract Asian buyers…but there is a 2 year ban of Foreign Investors buying residential real estate now. I don’t think there are a lot of wealthy Canadians, who would be buying these mansions and $10 million “summer homes”. The time for investor speculators is taking a pause.

    During the pandemic, many Millennials and people moved to small towns for affordability and to escape the crowded major cities, and that drove the prices up in small towns.

    I noticed that in small towns like Quesnel, B.C. now there are 109 properties for sale. And lots for sale in other small towns. Still…at expensive prices. Those sellers need to make a profit….they had a lot of expenses to move out there, and many were probably working remotely.

  • Philip 7 months ago

    We are can’t take what the BoC or the FED tells us with their carefully prepared remarks at face value. What now seams obvious with the inflation is transitory scapegoat narrative was obvious to many people including myself from the very beginning. Why? Because they can’t meaningfully fight inflation because of all the debt. All the debt that was only made possible by keeping rates way too low for way too long. The central bank has indeed painted itself into a corner in the name of kicking the can down the road and not having a healthy recession in the business cycle. The only reason they are raising rates now is because of the pressure they are getting to tackle what was never transitory inflation and to keep up the another narrative of their credibility. Credibility I am shocked they even still have after all that has happened since 2008.

    All this talk about bringing rates up to what is “neutral” is laughable. Of course you need rates higher than neutral to fight inflation, way higher. There has never been a time where inflation was so high and rates were essentially at 0. Also, inflation is much higher, closer to double than what is officially reported if it was calculated like it was back in 1980 but that is a story for another day. If they were actually serious in fighting inflation they would raise rates today, they would have started raising rates last year. They did not because they can’t. I will remind everybody reading this that the peak in the BoC overnight lending rate was 1.75% in January of 2020. Even if they bring the overnight lending rate to neutral which they are saying is between 2 and 3% would put it past the previous top breaking a 40 year cycle of never going higher then the previous peak. They cannot raise rates significantly past neutral to tackle inflation because that would easily crash the markets. Markets that the central banks inflated and propped up every time they have faltered in the past 14 years through QE and low rates. Does anybody actually think it will be different this time considering the never before seen amount of debt created through QE in the past 2 years.

    Therefore the multi-trillion dollar levered debt bomb question is not if but when central bank will pivot to rescue the capital markets going past 1.75% for the BoC and 2.5% for the FED effectively destroying what little if any credibility they have left. Oh and did I mention their plans for balance sheet reduction at the same time as well…

  • Jean 7 months ago

    How will wages respond to respond to rate increases. Canada has had stagnate wages since the 1980s when the the BOC raised interested rates, if this trend repeats in the next few years Canadians will be in deep trouble and well on its way to becoming a northern version of Argentina. Noticed no corresponding change in saving interests rates and little talk of an increase. The UK did pass along increased rates to savers.

  • P Rao 7 months ago

    Why make first time homebuyers suffer. Wouldnt it be helpful (inflation or no inflation), first time homebuyers should be able to get a lower rate compared to investors or multiple home owners. It’s not the first time home onwers who are pushing the prices up, why are they made to suffer.

    • Gerald Haw 7 months ago

      It’s the opposite. Low rates allow the borrower to pay more to buy a home and drive prices higher.

      • P Rao 7 months ago

        Agreed, but also considering the situation of a first time homebuyer, their buying power isnt extravagant (usually tend to shop around 500-800k mark).
        So it would make sense to give them a lower rate upto a certain upper limit.
        Maybe BOC can make a checklist of criterias(example: 1) is the buyer a 1st time homebuyer)
        2) Property offer made not exceeding the xyz limit(500k limit or as deemed fit)

    • Piet 7 months ago

      Higher rates are great for first time buyers and painful for investors. So rising rates exactly does what you want, create a better environment for first time home buyers.

      Higher rates will drop prices down so people who are saving for a down payment see their money afford more house.

  • This Will End Badly 7 months ago

    I think what most of us don’t understand is that a 20-30% drop not only means the value of our home will fall, it also means that when you renew your mortgage loan the bank/lender will only give you a amount based on the current value of of home. Meaning, if you have a 1mil home and it drops by 30% the bank will only give you 700,00K.

    Let that sink in for a minute….

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