The Bank of Canada left interest rates unchanged last week, but acknowledged growing inflation challenges and the likelihood that interest rates will start rising earlier than previously expected.

“…the main forces pushing up prices–higher energy prices and pandemic-related supply bottlenecks–now appear to be stronger and more persistent than expected,” the Bank said in its statement. “The Bank is closely watching inflation expectations and labour costs to ensure that the temporary forces pushing up prices do not become embedded in ongoing inflation.”

With inflation running hotter than expected and supply chain issues growing, the Bank changed its forward guidance on the timing of rate hikes, saying, “this happens sometime in the middle quarters of 2022.”

“The Bank of Canada has taken a hard turn amid ramped-up inflation concerns, and even amid a milder growth backdrop,” wrote Douglas Porter, chief economist for BMO.

“For now, we would assume that rate hikes progress quarterly until late 2023, bringing the overnight rate back in line with pre-pandemic levels two years hence,” he added. “Clearly, the risks are tilted to an even earlier move, and—yes—the possibility of a faster cadence, and a higher endpoint.”

Some economists see rate hikes starting as soon as April, which would fall at the earliest point of the BoC’s “middle quarters of 2022” guidance.

“An April start to tightening looks increasingly likely as long as we see continued progress in the economic and labour market recovery over the next six months,” wrote RBC economist Josh Nye.

The Bank of Canada also released its latest Monetary Policy Report and adjusted some of its growth and inflation forecasts.

The Bank now sees CPI inflation averaging 3.4% for the remainder of 2001, higher than its previous forecast released in July. It expects inflation to persist at 3.4% throughout 2022 (up from 2.4%) and fall back to 2.3% in 2023 (up from 2.2%).

Growth forecasts, meanwhile, were trimmed to 5.1% for 2021 (down from 6% in its July forecast). The Bank sees GDP falling to 4.3% in 2022 (down from 4.6%) and 3.7% (up from its earlier estimate of 3.3%).

The Bank also ended its Quantitative Easing (QE) program, which saw the bank purchase billions of dollars worth of bonds throughout the pandemic to assist with market liquidity.

At the height of the program, the Bank was buying up to $5 billion worth of bonds each week, but that was gradually reduced to $2 billion in recent months. The Bank said it will move to a reinvestment phase, meaning it will purchase bonds “only to replace those that are maturing so that our overall holdings of Government of Canada bonds remain roughly stable over time.”

Bond yields on the rise

The 5-year Government of Canada bond yield, which typically leads 5-year fixed mortgage rates, jumped over 10 basis points following the announcement. Since September 2020, yields are up over a full percentage point.

Banks and other mortgage lenders have been steadily raising their fixed rates over the past month, but observers expect a fresh round of hikes if the current bond yields movements hold.

Housing analyst Ben Rabidoux, founder of Edge Realty Analytics, noted that the last time 5-year bond yields were at these levels, deep-discounted 5-year fixed mortgage rates were in the 2.70%-range.

“That implies about 60 bps of hikes are coming in the next few weeks unless bond yields reverse course,” he wrote.

As always, we’re monitoring developments as things evolve, but our advice remains the same: contact your broker to discuss how this may impact you.