Bank of Canada surprises markets with largest rate hike in 24 years By Reuters

2/2© Reuters. FILE PHOTO: A sign is ig foreign exchangepictured outside the Bank of Canada building in Ottawa, Ontario, Canada, May 23, 2017. REUTERS/Chris Wattie2/2

By Julie Gordon and Steve Scherer

OTTAWA (Reuters) -The Bank of Canada on Wednesday raised its main interest rate by 100 basis points in a bid to crush inflation, surprising markets and becoming the first G7 country to make such an aggressive hike in this economic cycle.

The central bank raised its policy rate to 2.5% from 1.5%, its biggest rate increase in 24 years, and said more hikes would be needed. Economists and money markets had been expecting a 75-basis point increase.

"We had indicated we were prepared to be more forceful. Today was more forceful," Governor Tiff Macklem told a news conference after the decision.

"Yes, it is a very unusual move to increase by 100 basis points at one decision and that really reflects the very unusual, exceptional circumstances that we find ourselves in."

Earlier, the central bank said excess demand, high inflation felt across sectors and rising consumer expectations of persistent price gains prompted the super-sized hike, which lifted the policy rate to its highest level since 2008.

"If this doesn't get us back into the idea that the Bank of Canada is serious about bringing inflation down, I don't know what would," said Jay Zhao-Murray, a market analyst at Monex Canada.

The Bank of Canada's move follows a 75 basis point rate hike by the U.S. Federal Reserve last month.

"The Bank of Canada saw the Fed hike 75 bps and said 'Hold my beer,'" said Royce Mendes, head of macro strategy at Desjardins Group, noting hawkish language in the statement that accompanied the "colossal move."

SOFT LANDING

In its July forecasts, also released Wednesday, the Bank of Canada made clear it expected inflation to rise further, saying it would remain around 8% in the next few months. Canada's inflation rate hit 7.7% in May, near a 40-year high.

The central bank now sees inflation averaging 7.2% this year, falling to about 3% by the end of 2023 and then back to the 2% target by the end of 2024.

The Bank of Canada has been playing catch up with hot inflation for months, prompting rare attacks from critics and fueling worries that Canadians could lose faith in its ability to contain prices, leading to price spirals.

"Our forecast is for soft landing. As I said, the path to that soft landing has narrowed," said Macklem, who participated in the decision remotely after recovering from COVID-19. "And that is an important reason why we took stronger action today to front-load policy interest rates."

Still, the 100-bp move coupled with a warning of more hikes to come could spook markets, said economists.

"I think the market is going to be on edge here about the possibility of more upside surprises on rate hikes," said Doug Porter, chief economist at BMO Capital Markets.

SLOWER GROWTH

The policy rate is now at the nominal neutral rate - the midpoint between 2% and 3% - where monetary policy is neither stimulative nor restrictive.

The Canadian dollar was trading 0.5% higher at 1.2950 to the greenback, or 77.22 U.S. cents.

The bank also cut its economic growth forecast for this year to 3.5% from a previous estimate of 4.2%. It predicted growth would then slow to 1.8% in 2023 before rising to 2.4% in 2024.

The slower growth is "largely due to the impact of high inflation and tighter financial conditions on consumption and household spending," the bank said.

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