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The Bank of Canada indicated that persistent price pressures are making it more likely policymakers will need to raise borrowing costs to contractionary levels in order to keep inflation expectations anchored.
In a speech a day after the central bank raised its benchmark overnight rate by a half percentage point to 1.5%, Deputy Governor Paul Beaudry gave new guidance Thursday on how high borrowing costs could rise. The policy rate may now go to the top, or even above, what the Bank of Canada considers its “neutral range,” estimated at between 2% to 3%.
During their policy deliberations this week, Beaudry said officials discussed how price pressures continue to surprise on the upside and are broadening, with inflation poised to move even higher before easing.
“This raises the likelihood that we may need to raise the policy rate to the top end or above the neutral range to bring demand and supply into balance,” Beaudry said in prepared remarks of the speech provided to journalists. He was speaking in Gatineau, Quebec.
The comments will firm up market expectations the central bank may need to increase rates to levels that more actively slow economic growth in order to contain three-decade-high inflation.
The Canadian dollar advanced on the news, gaining 0.4% to C$1.2606 per U.S. dollar at 10:57 a.m. in Toronto trading. Yields on Canadian government two-year bonds were up 3 basis points to 2.82%.
Investors had already raised bets on Wednesday for a higher terminal rate and faster pace of tightening, after the central bank said in its policy decision it was prepared to act “more forcefully” if needed to control inflation.
Half point increases are now fully priced in for policy meetings scheduled in July and September, with traders seeing the rate maxing out at about 3.25%. The policy rate was as low as 0.25% earlier this year, before the central bank began its hiking cycle in March.
Beaudry used much of the speech to outline how the central bank is trying to prevent inflation from becoming entrenched and self-fulfilling by keeping inflation expectations anchored.
He also defended the central bank’s decision not to start hiking rates until March this year, but said the situation has changed.
“The bottom line is that the risk is now greater that inflation expectations could de-anchor and high inflation could become more entrenched,” Beaudry said.