Bank of Canada’s aggressive rate hike risks plunging the economy into recession, costing hundreds of thousands of jobs, economists warn

In its zeal to crack down on inflation, the Bank of Canada risks plunging the Canadian economy into recession and costing hundreds of thousands of people their jobs, economists warned after the Bank raised its key overnight lending rate for the fifth time this year.

The Bank of Canada raised its rate by three quarters of a percentage point, to 3.25 per cent, Wednesday morning - and says more hikes are coming as it tries to wrestle inflation.

Given the outlook for inflation, the Governing Council still judges that the policy interest rate will need to rise further. Quantitative tightening is complementing increases in the policy rate," the Bank said in announcing the increase. The Governing Council remains resolute in its commitment to price stability and will continue to take action as required to achieve the two per cent inflation target."

Financial institutions started raising their prime rates in response to the Bank of Canada's announcement. That means higher variable rate mortgages now, and eventually higher fixed rate mortgages when people renew, said James Laird, co-CEO of Ratehub.ca

Fixed-rate mortgage holders should budget for today's higher rates when their next renewal comes up," said Laird.

Calling the two per cent inflation target arbitrary," David Macdonald, senior economist at the Canadian Centre for Policy Alternatives, said the aggressive tone makes the Bank's goal clear: Control inflation, no matter what the cost.

It starts to dispense with the idea of a soft landing, and moves more toward the idea that we'll reach the two per cent goal, whether there's a recession or not, whether there are job losses or not," said Macdonald, who estimated up to 850,000 people could lose their jobs in a recession if the Bank sticks to its two per cent inflation goal. There's a sign on the road saying recession ahead,' and we're heading straight for it."

Douglas Porter, chief economist at BMO, agreed that a recession is a distinct possibility.

That's clearly the risk here. They've got to be careful not to overdo it," said Porter, who was surprised by the tone of the Bank's announcement.

A lot of people thought that maybe this would be the last rise. This statement certainly puts an end to that thinking," said Porter.

Porter expects the Bank to raise rates by another half a percentage point by the end of the year, but suggested three quarters isn't out of the question.

Data from Statistics Canada showed prices were 7.6 per cent higher in July than they were a year earlier, as measured by the basket of goods in the Consumer Price Index. That's down slightly from the 8.1 per cent year-over-year increase seen in June.

In July, the Bank stunned observers by raising the overnight rate by a full percentage point, to 2.5 per cent.

The overnight rate began the year at 0.25 per cent, where it had been since the Bank of Canada dropped it three times in a month in March 2020, as the global COVID-19 pandemic was declared.

The increase comes in the wake of preliminary evidence that Canada's economy shrank slightly in July. Last week, Statistics Canada said early data showed that real gross domestic product fell 0.1 per cent in July from June.

That slowdown, suggested Conference Board of Canada chief economist Pedro Antunes, is happening even before the full impact of this year's rate hikes has been felt.

The real bite won't happen for a while, until people go to renew their mortgages," said Antunes. Right now, it's mostly people's expectations that's causing a bit of a slowdown. People see the increases, and worry about more rate hikes, so they pull back their spending a bit."

Those expectations - by consumers and businesses alike - are likely part of the reason for the Bank's hawkish language on inflation, said Antunes.

The rationale for raising interest rates is that making it more expensive to borrow money means businesses and consumers will spend less. Lower spending means less demand for goods and services, meaning prices could drop, or at least rise less quickly. Enough of a slump in demand, and the economy starts to shrink. Two straight quarters of a shrinking economy? That's a recession.

But if people get spooked enough about the potential for future rates, that drop in demand could happen even before the Bank moves again, Antunes said.

Inflation expectations are a big part of what the Bank looks at," said Antunes, who nonetheless expects another rate increase or two this year.

A four per cent rate isn't out of the question," Antunes said.

While there's a risk of recession, Antunes doesn't believe it's a sure thing. Still, raising interest rates is the only way the Bank can try to get inflation under control, he added.

It's a blunt tool, but it's really the only one they've got," Antunes said.

Josh Rubin is a Toronto-based business reporter.