Bank of Canada rate forecast gets another upward revision at BMO

Canadian variable rate mortgage borrowers—stay tuned. BMO Capital Markets made another upward revision to the interest rate forecast this week. The bank was forced into a review as sticky inflation and rising wages require much higher interest rates to cool activity. Canada’s overnight policy rate is forecast to hit its highest level in more than ten years, which doesn’t bode well for home prices.

The Bank of Canada’s policy rate forecast rises again

The Bank of Canada (BoC) surprised many with its rate hike earlier this month. Despite market prices at 75 basis points (bps), the central bank went with a 50 bps move. At 3.75%, the policy rate is now the highest in a decade, and many believed that a smaller increase signaled that we were close to the peak. Not exactly.

BMO has just raised its forecast for the terminal rate, the point at which rates peak. They see the BOC making an additional 50 bps, now at a terminal rate of 4.5%. This would be 25-50 bps below the target for the US Federal Reserve, potentially leading to a weaker loonie.

Sticky inflation and rising wages are driving up costs

Interest rates have risen in an attempt to slow inflation, which is driving the current upward revision. “The reason for the increase (again) is stubborn core inflation and wage growth, the latter of which is still strong amid labor market conditions. This means central banks still have more work to do to restore price stability,” said BMO economist Michael Gregory.

Economists warned of the possibility of an inflationary spiral if left too high for too long, and that could be the case here. An inflationary spiral occurs when high inflation erodes wages so quickly that workers need much higher raises to cope. Since wages are input costs, the higher the increase the higher prices must rise to accommodate the increase. Higher prices are due…you get the picture.

“On both sides of the border, the overlapping inflation and wage growth points to a spiraling wage-price spiral that will require more aggressive central bank tightening to reverse it,” Gregory said.

If the terminal rate forecast comes through, Canadians will face a policy rate rarely seen in this generation. In the last 20 years, only six months in 2007 have matched the forecast level. This means house prices will need a major adjustment, as former BoC governor Poloz recently mentioned.

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