Canada’s largest bank is accelerating its forecast for higher interest rates. RBC sees the Bank of Canada (BoC) doubling the overnight rate at the April meeting. The bank is also accelerating its forecast, seeing a sharp and fast tightening cycle. By year end, they expect the overnight rate to hit the highest level in over a decade.
Bank of Canada Forecast To Double The Overnight Rate This Month
The BoC is expected to take an aggressive stance on interest rate hikes, trying to keep up with the US. RBC is now forecasting a 50 basis point (bp) hike at the April meeting. This would double the current level, and bring it half-way to the pre-2020 rate. Four additional 25 bp hikes are forecast for the rest of the year, ending at 2.00%. They believe the BoC will front-load the tightening, with no further moves next year.
Before the most recent cuts to the overnight rate, the previous cycle had peaked at 1.75%. If the overnight rate reaches 2.0% as forecast, it won’t just surpass that level. It would hit the highest level since 2008. Assets are priced at post-Great Recession capital costs, with Great Recession level interest rates. That’s another article for another day, but it will be interesting to see the market react.
Soaring Inflation and Housing Are Driving Rates Higher, But The Economy Can Take It
Canada’s economy is more than prepared for higher interest rates — it needs it, argues the bank. A multi-decade high for inflation and record home price growth need friction. Steep inflation growth indicates rates should have been climbing sooner. RBC argues the fast cycle will be due to falling behind the curve. Now the central bank will need to play catch up.
“Having committed to keep rates low until their economies fully recover, both are increasingly worried they’ve fallen behind the curve on inflation,” said Josh Nye, a senior economist for the bank. “Rapidly-declining jobless rates, broadening inflation and ongoing commodity and supply chain pressures have added to the urgency to scale back stimulus.”
The pressure from out-of-control inflation and surging wage growth are due to stimulus. Stimulus creates elevated demand, which some argue has been excessive. When paired with strong economic growth and a tight labor market, RBC doesn’t see anything stopping higher rates.
“All told, it’s hard to see a catalyst for the BoC pausing its tightening cycle in the next few quarters,” says Nye. “The effect of front-loaded rate increases is likely to build in 2023, slowing consumer spending and weighing on housing activity which has accounted for a disproportionate share of GDP during the pandemic recovery.”