Interest rate hikes should lead to a recession, study warns

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Interest rate hikes should cause recession, study warns

Statistics Canada said last week it expects gross domestic product to contract by 0.2% for the month of May.

The Bank of Canada's strategy of rapidly raising its key interest rate in an effort to combat accelerating inflation will likely trigger a recession, new research from the Canadian Policy Center finds alternatives (CCPA).

According to the study, the central bank has had a 0% success rate with this approach over the past 60 years. The analysis points out that annual inflation fell by 5.7 percentage points on three occasions during this period, each time after sharp interest rate hikes followed by a recession.

The research institute notes that the central bank's operation to bring inflation down from 7.7% to its target of 2.0 % by rapidly raising rates could result in significant collateral damage, including the loss of 850,000 jobs. It further calls on the central bank to adopt a new policy on inflation to reduce this risk.

Economist Jennifer Lee of BMO Capital Markets expects the Bank of Canada's key interest rate to rise by three-quarters of a percentage point next week. According to her, the rapid and dynamic increases are sure to lead to a significant slowdown in economic growth.

Whether or not this is an official recession remains to be seen, but clearly it will be a significant slowdown, she explains.

She notes that the central bank currently has few alternatives to fight inflation.

“Bigger rate hikes are needed right now to kill this inflation monster as soon as possible.

—Jennifer Lee, BMO Capital Markets

David Doyle, head of economics for the Macquarie Group, is also betting on a three-quarter point rise this month, and predicts a recession in 2023 in Canada and the United States.

We expect the contraction to be greater in Canada because of its more serious structural imbalances, such as housing investment and consumer debt levels, explains- he.

Canada is already experiencing a slowdown in economic growth and is even seeing layoffs in some sectors, such as technology. Expect a contraction in gross domestic product (GDP) of 0.2% for the month of May, amid weakness in the resource, manufacturing and construction sectors.

The level of Canadian household debt relative to their disposable income hit a record high in the fourth quarter, according to Statistics Canada.

The CCPA says the Bank of Canada could reduce the risk of sending the economy into recession by adjusting its target inflation rate to 4.0%.

The study highlights how the bank successfully avoided a recession when aiming for smaller cuts in inflation. This approach has allowed it in the past to introduce smaller rate increases over longer periods.

However, David Doyle believes that raising the inflation target to 4.0% would be a bad idea.

It would harm the credibility and independence of the Bank of Canada and would create more uncertainty, says the economist. It would also increase the risk of a severe downside scenario, where there would be an unanchoring of consumer and business inflation expectations.

The study The CCPA comes a day after the release of two quarterly Bank of Canada surveys, which revealed that consumers and businesses expect inflation to remain high for several years, increasing the probability of seeing a three-quarters of a percentage point rise next week.

Economist Jennifer Lee estimates that inflation will likely return to 3.0% in the coming week. #x27;by the end of 2023, before dropping to its target rate of 2.0% in 2024 or 2025.

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