The Bank of Canada’s strategy to quickly raise its key interest rate in an attempt to tackle soaring inflation is likely to trigger a recession, according to a new study released Tuesday by the Canadian Center for Policy Alternatives (CCPA).
The study showed that over the past 60 years, the central bank has on three occasions managed to reduce inflation by 5.7 per cent by rapidly raising interest rates, and each occasion was followed by a recession.
The research institute said that if the central bank aims to reduce inflation from 7.7 percent to its two percent target by quickly raising interest rates, it could cause significant “collateral damage”, including the loss of 850,000 jobs, and calls for a new policy on inflation targeting to reduce this risk.
Jennifer Lee, senior economist at BMO Capital Markets, which expects a 0.75 percentage point interest rate hike from the Bank of Canada this month, said quick and aggressive hikes would “certainly” cause a significant slowdown in economic growth.
“It remains to be seen whether this will be an official recession, but clearly a significant slowdown,” she said.
She also said there are few alternatives the central bank currently has at its disposal to deal with inflation.
“We need interest rate hikes right now — bigger hikes — to kill this inflation monster sooner rather than later,” she said.
David Doyle, chief economist at Macquarie Group, which also expects a 0.75 percentage point increase, predicted a recession in 2023 in both Canada and the United States.
“We expect the contraction to be larger in Canada because of the more severe structural imbalances, such as housing investment and consumer debt levels,” he said.
Canada is already experiencing a slowdown in economic growth and is even seeing layoffs in some sectors, such as technology.
Statistics Canada said last week it expected GDP to contract by 0.2 per cent in May amid weakness in the resources, manufacturing and construction sectors.
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In its study, the CCPA said the Bank of Canada could potentially reduce the risk of sending the economy into recession by adjusting its target inflation rate to four percent. The study highlights how the bank successfully avoided recession when it aimed for smaller cuts in inflation, allowing the bank to introduce smaller rate increases over a longer period.
But Doyle said raising the inflation target to four percent would be a “bad idea.”
“It would damage the credibility and independence of the Bank of Canada and create more uncertainty,” he said. “It would also increase the risk of a severe downside scenario where there is a shift in consumer and business inflation expectations.”
The CCPA survey comes a day after the Bank of Canada released two quarterly surveys that revealed consumers and businesses expect inflation to remain high for several years, further increasing the odds of a 0.75 percentage point rate hike this month.
While speaking to reporters at an event in Brampton, Ontario. on Tuesday, Deputy Prime Minister Chrystia Freeland was asked about the CCPA study and said the Bank of Canada is well-prepared to deal with the inflation problem.
“He has the tools and the expertise to (bring down inflation). And I think we should all be confident that the Bank of Canada is going to do its job,” she said.
As for how long it might take to even reach the central bank’s two percent inflation target, BMO’s Lee said we were likely to see three percent inflation by the end of 2023, with the possibility of another two percent in 2024 or 2025
This report by The Canadian Press was first published on July 5, 2022.
Adena Ali, The Canadian Press
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