In early June, the Bank of Canada held its key lending rate at 0.25%, despite inflation running at its hottest levels in 10 years. The reasoning is that inflation is primarily spiking because the Canadian economy was shut down a year ago due to the coronavirus pandemic. Once the economy fully opens later this year, inflation levels will taper off.
As a result, there is no need to raise interest rates to cool the red-hot economy down.
But there are growing concerns that the spike in inflation may not be temporary and that central banks, including the Bank of Canada and U.S. Federal Reserve may have to raise their key policy rate sooner rather than later.
Why Is High Inflation Bad for Stocks?
As we saw earlier this year, stocks suffered a blow when yields started to climb even moderately higher. A prolonged hike in interest rates could cause stocks to pull-back or remain volatile.
And it’s looking like that’s a possible scenario. According to the Bank of America, consumer prices are expected to soar for up to four years as the Federal Reserve (and by extension the Bank of Canada) combats inflation that is at decade highs.
The Bank of America noted that U.S. inflation will remain in the range of two percent to four percent over the next two to four years. We’re already past that number. In May, U.S. inflation rose 5% year-over-year—the biggest jump since the 5.3% increase in August 2008.
In Canada, the May inflation rate increased to 3.6%, the fastest pace in a decade. It’s becoming a pattern; April’s inflation reading of 3.4% was, at the time, the fastest annual rate hike in nearly a decade.
Central banks have said they won’t raise their lending rates because the inflationary hikes are temporary. The Bank of Canada has said it expects to keep its overnight rate in 2021 at 0.25%, rising to 0.5% in 2022.
What Could Stop Central Banks from Raising Interest Rates?
But with inflation spiking so quickly and the Canadian and U.S. economies getting even hotter, it’s looking more and more likely that they will need to step in and raise interest rates. In fact, according to the Bank of America, the only thing that could really prevent central banks from tightening their lending policies over the next six months would be a stock market crash.
On the other hand, if central banks raise interest rates, or do so too quickly, it could dent growth which would also weigh down stocks.
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Canadian and American stocks are at record levels and inflation is spiking. Central banks have said they won’t raise their interest rates because the spikes are temporary. But some speculate inflation will remain elevated for up to four years, which means central banks will need to raise their interest rates to keep the economy in check.
The trading professionals at Learn-To-Trade.com can show you which equities do well when interest rates rise and which ones to avoid.
Learn-To-Trade.com is Canada’s oldest and leading provider of stock market trading courses. Over the years, we’ve taught thousands of investors, of every skill level, how to read economic cycles, spot market trends, and become confident traders that profit more consistently. To learn more about Learn-To-Trade.com’s stock market trading course, contact us at 416-510-5560 or by e-mail at info@learn-to-trade.com.
