The Bank of Canada sent a message this week that it’s serious about taming record-high inflation.

It delivered a surprise 100-basis-point hike to its benchmark lending rate on Wednesday, bringing it to 2.50%. It was the Bank’s largest hike since 1998 and brings the overnight rate to its highest level since 2008.

The market consensus had been for a 75-bps rate hike, but the Bank of Canada said it chose to “front-load” the path to higher interest rates with “the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer.”

The Bank admitted CPI inflation, which is now at 7.7% as of May, is “higher and more persistent” than what was originally forecast.

As a result, in its latest Monetary Policy Report, the Bank revised its inflation forecasts yet again. It now expects CPI inflation to average 7.2% in 2022 (up from 5.3% in its previous forecast), 4.6% in 2023 (up from 2.8%) and 2.3% in 2024 (up from 2.1%).

“Our goal is to get inflation back to its 2% target with a soft landing for the economy,” Bank of Canada Governor Tiff Macklem said during his post-announcement press conference. “To accomplish that, we are increasing our policy interest rate quickly to prevent high inflation from becoming entrenched. If it does, it will be more painful for the economy—and for Canadians—to get inflation back down.”

Dan Pultr, Senior Vice President, Strategic Initiatives at TMG The Mortgage Group, said the larger-than-expected hike shows the Bank is “committed to stemming inflation by any means,” even if it risks throwing the economy into a recession. 

“While this will undoubtedly create fear among many variable rate mortgage holders, the key is to look out over a longer horizon and look at how similar tightening periods have played out in history,” he said. “I and many economists remain committed to the belief that this tightening period will eventually need to be counter-balanced by stimulus as the economy begins to feel the impacts of the BoC’s monetary policy decisions.”

TD Bank economist James Orlando agrees that this magnitude of a rate hike raises the risk that the economy tips into recession, but that “the Bank has to accept this risk (and possible outcomes) in order to prevent high inflation expectations from becoming even more entrenched,” he wrote.

“This big step up in rates is uncommon, so too is the economic backdrop,” he added. “With the unemployment rate at 4.9%, wages running at 5.2%, and inflation at 7.7%, the pressure on the BoC has not let up.”

The immediate impact on variable-rate mortgage holders

Following Wednesday’s rate announcement, all of Canada’s Big 6 banks announced increases to their prime rates of 1.00%.

The majority of variable-rate mortgage holders have fixed monthly payments. So, while their monthly payment won’t change, a larger percentage of that payment will now go towards the interest portion, while a smaller percentage will go towards paying down the principal balance.

Those with adjustable-rate mortgages, however, will see a rise in their monthly payments. Generally, a 100-bps increase in rates will translate into about $55 more per month per $100,000 of mortgage debt, based on a 25-year amortization.

For those concerned about rising monthly payments, a mortgage broker can go over all of the options that are available to you.