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The Bank of Canada may have raised its inflation forecasts, but it didn’t raise interest rates this week as many had expected. 

At its first rate policy meeting of the year, the Bank of Canada confirmed that slack in the economy has now been absorbed, signalling the way for interest rates to start rising…just not yet. 

Despite markets pricing in a high likelihood of a 25-basis-point rate hike, the BoC signalled that it wouldn’t be pressured by markets, and instead opted for a more paced and planned start to its rate-hike cycle.

In remarks during a press conference following the Bank’s policy decision, Governor Tiff Macklem said, "The message is pretty clear. We're on a rising path.”

"How far and how fast? Those are decisions we'll take at each meeting, depending on economic developments, depending on our outlook for inflation, and what we judge is needed to bring inflation back to target,” he said. 

In its statement, the Bank’s Governing Council said inflation—which reached a 30-year high of 4.8% in December—is expected to "decline reasonably quickly” to around 3% by the end of this year, before gradually easing to the target of 2%. But not before peaking above 5% in the first quarter. 

In its latest Monetary Policy Report released this week, the Bank now expects CPI inflation to come in at 4.2% for 2022 (higher than its initial forecast of 3.4%), and stuck with its forecast of 2.3% for 2023. 

"The Bank will use its monetary policy tools to ensure that higher near-term inflation expectations do not become embedded in ongoing inflation,” the statement added.

Reaction to the Bank’s decision

Reaction to the BoC’s rate decision was swift, with many criticizing the decision to wait until March or April to begin raising rates. 

"While the Bank opted not to get the tightening cycle underway, it’s clear to us that a rate hike is effectively a foregone conclusion in March,” economists from the National Bank of Canada wrote. "Indeed, the BoC essentially did everything but hike today. With them abandoning forward guidance and highlighting slack has now been absorbed, it begs the question why they just didn’t start hiking today.”

Meanwhile, TD Bank senior economist James Orlando said inflation should be the Bank’s main concern. 

"From our lens, the BoC needs to move quickly,” he wrote. "We expect a rate hike in March and three more in 2022. This should lift government bond yields and mortgage rates. Hopefully, this will cool some of the froth.”

Interest rate outlook for 2022

The bond market agrees and is now pricing in a 90% chance of a rate hike in March, with an additional four quarter-point rate hikes priced in for this year. 

That would bring the BoC’s target overnight rate to 1.50%, well above the 0.25% level it’s been sitting at since March 2020. 

That would lead to a rise in the prime rate, upon which variable rates are priced. As a result, variable-rate mortgage holders with floating rates would see their monthly payments rise. But for fixed-payment variable-rate holders, their monthly payment will remain the same while the portion of their payment going towards principal repayment will decrease as the interest portion increases. 

Anyone with further questions about the impact of rate hikes on their mortgage payments and wanting to discuss potential strategies please contact me today.