Liftoff! Bank of Canada raises rates — Implications for the broader market and investors

Published March 7, 2022

The Bank of Canada (BoC) raised its overnight target interest rate by 25 basis points (0.25%) to 0.5% on Wednesday, March 2. This marks the first time since 2018 that the BoC has raised rates. It is raising rates because of the strong economic growth in recent quarters; inflationary pressures that have been higher and more persistent than originally thought, pushing inflation above the bank's 2% target; and consumer spending that remained resilient even as omicron case counts rose.  The bank projects additional rate hikes will be necessary to tame inflation, but it noted that the rate-hiking path is not set in stone. The Ukrainian conflict is likely to add to uncertainty about commodity prices and global economic growth in the long run, with flight paths already readjusting to sanctions and restrictions imposed by the wider global community. Here's our three key takeaways:

  1. Inflation: Inflation is at multidecade highs, hitting a 5.1% annualized rate in January, keeping real yields firmly in negative territory1. However, a large part of current inflationary pressures come from a just few key sectors. A semiconductor shortage stemming from COVID-19-related factory shutdowns has seen used-car prices sharply increase nearly 7.2% in the last 12 months. Energy prices, which briefly turned negative in early 2020, have rebounded, and oil is now over $100/barrel and likely to move higher as the Russia/Ukraine conflict intensifies1. Lastly, food, and more specifically fresh produce, has seen higher-than-average price growth due to bad weather and supply-chain disruptions, like a shortage in new trucks and truck drivers. Grocery prices were up 5.7% in December on an annualized basis, the largest gain since 20111.

    Along with supply-chain disruptions, strong consumer spending has also been a big driver in rising prices. Retail sales in Canada grew 8.6% year-over-year in December and averaged just over 13% per month in 2021.  We think inflation will stay elevated throughout 2022 but should moderate towards the end of the year and into 2023 as chip shortages and supply-chain disruptions ease. Core inflation, which excludes volatile components like energy, could see a faster timeline to normalization than headline inflation if oil prices stay elevated.
  2. The Economy: Likely the biggest risk to the economy from rising rates is the housing market. Canadians now owe nearly $1.75 trillion in mortgage debt. As rates rise, home-price growth should slow, with buyers being priced out of the market due to higher monthly payments. Although Canada's economy will certainly feel the effects of BoC rate hikes, the U.S. Fed is likely to have a larger impact globally, as it considers balance-sheet normalization and its own set of rate hikes aimed at curbing inflation. The U.S. economy has seen similar trends in wage growth, consumer spending and inflation.

    Although GDP growth has been robust in 2021 and early 2022, interest-rate hikes will likely mean a moderation in GDP growth. Canada's economy grew at an annualized rate of 6.7% in the fourth quarter of 2021 and posted strong growth in January, which bodes well for the rest of the year. However, tighter monetary policy coming out of most major economies, excluding China, will likely tame inflation and reduce growth rates. The Ukrainian conflict could add a wrinkle to strong growth and slow the pace of tightening, but it's unlikely to change the long-term path, in our view. We think growth will moderate toward the end of the year, and interest rates will continue to rise, with the market pricing in a 1.75% rate by the end of the year, or six hikes in 2022. However, moderating growth doesn't mean an end to the economic expansion. The macroeconomic backdrop and recovering labor market mean the economy can continue to grow in a multiyear expansion, albeit at a slower pace with moderated inflationary pressures.
 Bank of Canada policy rate

Source: FactSet, Statistics Canada. This chart shows the recent rise in Canada immediate interest rate after BoC announced the hike on Wednesday March 2nd.

This chart shows that the TSX has been 1 of only a handful of major indexes up for the year with other major U.S. and international Large-Cap indexes lower.

  1. The Stock Market: 2021 was a relatively quiet year, with only 11 days trading lower than 1% compared with 37 in 20201. 2022 looks like it could be a volatile year, with several factors coming into play. Markets tend to dislike uncertainty, and the risk premium increases during these periods. Most major indexes are down, with technology shares being especially hard hit.

    The TSX Index has been a bright spot, up almost 1% as of Friday, March 4. The TSX has more exposure to value and cyclical sectors, such as energy, than the U.S. S&P 500, Nasdaq or Dow Jones. Just because rates are rising, though, doesn't necessarily mean markets will be negative. In fact, since 1994, stocks have ended central-bank hiking cycles higher than where they started in all but one instance1. We think that value and cyclical sectors, like energy firms and commodity producers, will continue to outperform in the near term.
 Year-to-Date performance of key indexes

Source: FactSet. Past performance does not guarantee future results. Market indexes are unmanaged and cannot be invested into directly.

This chart shows that the TSX has been 1 of only a handful of major indexes up for the year with other major U.S. and international Large-Cap indexes lower.

Actions for investors:

  1. Expect periods of heightened volatility stemming from tighter monetary policy, a Russia/Ukrainian conflict, and fluid inflationary pressures that will alter central-bank glide paths for rate hikes.

  2. Look for opportunity in value and cyclical sectors for your portfolio where appropriate. Your financial advisor can help with this process, looking for opportunities while staying true to your personalized goals, risk tolerance and time horizon.

  3. While we may continue to see an investor flight to traditional safe-haven assets in the near term, opportunities may be forming to buy quality investments at better prices.

Sloane Marshall,
Associate Analyst

Source: 1. FactSet. The TSX is an unmanaged index and cannot be invested in directly. Past performance is not a guarantee of future returns.

Important Information:

This is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

Investors should understand the risks involved in owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates and investors can lose some or all of their principal.

Past performance does not guarantee future results.

Market indexes are unmanaged and cannot be invested into directly and are not meant to depict an actual investment.

Diversification does not guarantee a profit or protect against loss in declining markets.

Systematic investing does not guarantee a profit or protect against loss. Investors should consider their willingness to keep investing when share prices are declining.

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