In response to growing concerns about persistent inflation and strong economic growth, the Bank of Canada (BoC) has raised its key overnight benchmark rate to 4.75%, reaching its highest level in 22 years.

The central bank had maintained the rate since January to assess the impact of previous hikes. Prior to this increase, borrowing costs had already been raised eight times since March 2022, bringing them to a 15-year high of 4.50% in what has been the fastest tightening cycle in the bank’s history.

The decision to raise the rate was driven by several factors, including surprisingly robust consumer spending, a rebound in service demand, increased housing activity, and a tight labor market. These factors indicate that excess demand in the economy is more persistent than originally anticipated, as stated in the BoC’s official statement.

In April, there was an uptick in inflation, and three-month measures of core inflation consistently hovered around 4% for several months. Consequently, concerns have intensified that Consumer Price Index (CPI) inflation could remain significantly above the 2% target set by the central bank.

Given this economic backdrop, the BoC’s governing council determined that current monetary policy was not sufficiently restrictive to rebalance supply and demand and achieve sustainable inflation at the 2% target. This prompted the decision to raise the key overnight benchmark rate to 4.75%.

Following the announcement, the Canadian dollar experienced a 0.5% increase, reaching 1.3330 per US dollar. Market analysts anticipate a near 60% chance of another rate hike in July, with further tightening fully priced in by September.

The last time the rate reached 4.75% was in April and May of 2001.

While money markets and analysts had predicted the possibility of a rate increase, many believed it would occur at the next meeting in July. A Reuters poll conducted with economists last week indicated that approximately two-thirds of respondents expected the central bank to maintain rates until the end of 2023.

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