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The Bank of Canada surprised the markets when it announced it was raising its key lending rate by 100 basis points in an effort to crush inflation. Canada’s central bank is the first country in the G7 to announce such an aggressive rate hike.

The Bank of Canada hiked its policy rate to 2.5% from 1.5%, which marks the biggest rate hike in 24 years. Analysts were expecting the central bank to raise its rates by 75 basis points.

The central bank said it needed to make this rate hike because of “higher and more persistent” inflation and the risk that elevated prices would become entrenched. It noted that the biggest drivers of global inflation include the war in Ukraine and ongoing supply chain disruptions, which have led to higher energy and food prices.

Bank of Canada governor Tiff Macklem has said that more rate hikes will be needed. Most analysts now believe the central bank will raise its key lending rate to a peak of 3.25%.

How Interest Rates Affect the Economy

Central banks cut their lending rates when they want to juice the economy by making it cheap to borrow and invest. When the economy gets overheated, central banks rise their rates.

The central banks key lending rate impacts mortgages and lines of credit. The Royal Bank and TD have already responded to the oversized rate hikes by increasing their prime lending rates to 4.7%. Other major banks are expected to follow suit.

In March 2020 the Bank of Canada slashed its rate to record lows of 0.25% to help stimulate the pandemic era economy. Since March 2022, it has raised its rates four times in an effort to fight inflation, which hit 7.7% in May, the highest level in almost 40 years.

The Bank of Canada expects the Canadian economy to grow by 3.5% this year, 1.75% in 2023, and 2.5% in 2024. As for high inflation, it’s here to stay for now. The central bank doesn’t expect inflationary pressures to start easing until later this year, falling to 3% by the end of 2023, and returning to the Bank of Canada’s target of 2% by the end of 2024.

Surging inflation is not limited to Canada. In the U.S. and U.K., the inflation rate is at 9.1%.

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By hiking its key lending rate by 100 basis points, the Bank of Canada is hoping to tame inflation and prevent a recession. But doing so makes everything more expensive for consumers and businesses.

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