Canadian inflation is slowing and that may prevent the Bank of Canada (BoC) from hiking rates further. The National Bank of Canada (NBF) warns that even if there’s no hike, a significant impact from previous rate hikes has yet to be felt. A rate hike takes years to work its way through the market, and only a little more than half the impact is currently reflected. Even without a hike, expect the impact of higher rates to continue to slow the economy in the near-term.
What The Heck Are Central Banks Doing With Interest Rates?
The primary goal of a central bank is to maintain a stable currency by ensuring low and stable inflation. The primary tool in their arsenal are interest rates, and since credit changes faster than supply chains can respond, they play a big role when it comes to influencing demand.
They respond to low inflation by slashing rates. The idea is cheap credit will help to overrun supply, causing higher prices in the short-term. High inflation does the opposite—higher rates help throttle credit used to fuel demand. It first shows up in large financed purchases like homes and cars, but eventually trickles downstream to the whole market.
Working its way through the economy takes time, since the slowing demand needs to work its way upstream. The impact on variable rate credit products might be immediate, but a whole chain reaction is required to slow inflation. Most central banks estimate it can take up to 8 quarters (2 years) to see the full impact of a monetary policy change.
Canada Has Yet To See The Full Impact of Previous Rate Hikes
Keep in mind the full impact of the first rate hike still may not have been fully felt. The BoC only began to raise rates about 18 months ago, with NBF estimating just 90% of the hike has reached the market. They believe nearly half the slowdown is still to come.
“Given the long lag between interest rate hikes and their full impact on consumption, there is every reason to believe that weakness will continue for some time,” explained NBF Deputy Chief Economist Matthieu Arseneau.
Adding, “Indeed, the Bank of Canada estimates that the impact of a rate hike on consumption is only entirely felt after 8 quarters, with the impact being essentially linear over two years.”
Arseneau believes only a minority of the rate hike has worked its way through the market. Since March 2022, Canada’s economy has only felt just 58% of the existing rate hikes. Their estimates show nearly none of the hikes in the third quarter have worked their way into the market.
Canada Will See Continued Economic Slowdown, Even Without More Hikes
Policy rate hikes per quarter since 2022, with or without the impact on current consumption.
Source: NBF Economics and Strategy; Refinitiv; Bank of Canada.
As a result of so much of the impact still to come, NBF doesn’t believe the BoC will risk overnighting. “…it would be perilous for the Central Bank to focus on the resilience of core inflation in its rate decision next week, as this indicator reacts with a lag to the economic situation which looks set to be moribund over the next 12 months,” said Arseneau.
In case it wasn’t obvious, they don’t see another hike this month. Though that doesn’t mean a flare up of inflation may not force the BoC to set expectations.