(Bloomberg) -- A Bank of Canada official said policymakers hiked in June because momentum in demand had increased the odds that inflation could get stuck above 2%, and noted that the neutral rate of interest may be higher than was previously believed.
In a speech to the Greater Victoria Chamber of Commerce a day after policymakers raised the benchmark borrowing rate to 4.75%, Deputy Governor Paul Beaudry flagged concerns about a reversal in core inflation and said officials were surprised by household spending on goods and services.
He also said that neutral rates — a theoretical level of borrowing costs that neither stimulate nor restrict the economy — may drift to higher levels compared to before the pandemic. Beaudry said stalling globalization, rising wages, and increasing investment opportunities in artificial intelligence as well as the transition to a low-carbon economy were contributing to the increase.
“A base-case scenario where the real neutral rate remains broadly in its pre-pandemic range is possible, but the risks appear mostly tilted to the upside,” Beaudry said, adding that there was “meaningful risk” neutral rates could go up.
Canada two-year bond yield rose about 3 basis points to 4.553% after Beaudry’s remarks were released.
While Beaudry was careful to note that the current neutral rate is still volatile, the comments will fuel speculation policymakers at the Bank of Canada are increasingly of the view their aggressive increases to interest rates are less restrictive.
It’s the first time in recent years the central bank has flagged that possibility after keeping the neutral rate forecast unchanged in April.
The statement, which came a day after the bank raised borrowing costs for the first time in three meetings, also highlighted the possibility rates need to move higher for longer in order to bring inflation to heel.
“A lot of uncertainty remains. But it’s possible long-term interest rates will be higher in the coming years than what Canadians are used to,” Beaudry said on Thursday. By outlining these key forces, Beaudry said he hopes he “will help people be prepared in the eventuality that we have entered a new era of structurally higher interest rates.”
Officials on Wednesday admitted that “monetary policy was not sufficiently restrictive to bring supply and demand back into balance and return inflation sustainably to the 2% target” and increased rates by 25 basis points to 4.75%, the highest since 2001.
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