Interest rate hikes 'going to be painful' for British Columbians, warns economist

The Bank of Canada is caught in a balancing act of triggering a recession and keeping the economy afloat, according to one B.C. economist.

Last week, Bank of Canada governor Tiff Macklem reiterated that the bank may have to move its key interest rate upwards of 3% to bring inflation back on target. He said the bank may need to "move more quickly, may need to take a larger step" to avoid inflation becoming entrenched."

“They're saying, if it takes us to trigger a recession, by increasing interest rates, we are willing to pay that price," says Giovanni Gallipoli of the University of B.C. "It's going to be painful."

As the cost of goods and services soars, interest rate hikes are a means to cool demand and put less pressure on prices, explained Gallipoli.

Inflation becomes dangerous when people’s expectations of it become “entrenched,” triggering a “vicious cycle” of price increases with wages unable to keep up, he said.

“If you don't do it now [increase interest rates], you run the risk of things overheating, and then expectation becomes embedded and it becomes a lot harder for monetary authorities to keep the prices in check,” said Gallipoli.

“The reasonable thing is to take the heat now and avoid a bigger heat later.”

Inflation has been caused by printing more money during the COVID-19 pandemic. It has surged ahead thanks to supply chain disruptions, trade restrictions, particularly with China, and Russia’s invasion of Ukraine interrupting production and supply of basic staples such as oil and wheat.

The Bank of Canada sets what’s called an overnight interest rate, now at 1.5%, up from 0.25% in December 2021. Prime rates are the higher rates banks charge on loans. Right now, the prime rate is 3.7%.

Low rates have overstimulated the economy with more borrowed money in the system, causing asset prices to inflate.

“If your mortgage is a fixed rate at 2%, like many people have, with an inflation rate of 7%, effectively the bank is paying these people 5% in real terms, to borrow money. That's very stimulative,” explained Gallipoli.

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