The Bank of Canada’s smaller-than-expected rate hike increases the chance of running behind the curve, and the central bank might have to make up for it later, according to Earl Davis, head of fixed income at BMO Global Asset Management.

On Wednesday, the central bank hiked interest rates for the sixth-straight time. The Bank of Canada increased its benchmark overnight lending rate by 50 basis points, bringing it to 3.75 per cent.

Davis said the majority of economists were expecting a hike of 75 basis points or more.

“It surprised us as well, we think as a team that increases the likelihood of being behind the curve,” Davis said in an interview with BNN Bloomberg on Thursday.

He added that since the Bank of Canada didn’t hike by as much as the market was expecting, it “will have to make up for that in a year's time by raising double, or three times that amount of 25 basis points.”

“The key thing right now is to break the back of inflation, the psyche of the market and people, so that we don't get this wage-price spiral,” he said.



Davis said that while the Bank of Canada surprised economists, he thinks the decision was justified, with the U.S. Manufacturing Purchasing Managers Index data released this week pointing to slowing economic activity south of the border. 

But he said that the Bank of Canada has to be weary of chronic inflation.

“What you do not want is chronic inflation, I mean inflation goes up, comes down, but then goes back up,” Davis said.

“To get rid of chronic inflation, you raise the rates higher now.”



The Bank of Canada has its last interest rate hike of the year scheduled for Dec. 7.

Davis said he still expects interest rates could get to six per cent, but after seeing the central bank’s change of strategy this week, he thinks there could be a pause at around 4.25 per cent.

He used the analogy of putting out a three-alarm fire. Once the fire itself is out, firefighters will wait outside to make sure it doesn’t pick back up again.

“So they're (the Bank of Canada) going to pause and that's the fire truck outside the house,” Davis said.

“But we think it'll pick back up (inflation) and they'll have to resume (hiking rates more aggressively) by the second half of next year.”