Two weeks after his next interest rate announcement, Federal Reserve Chairman Jerome Powell’s next step in the fight against inflation seems all but guaranteed.
Pressure on Powell is mounting, especially after Canada’s bond announcement of an exorbitant 0.75% increase in its country’s borrowing rate on September 7.
The move adds more stress to Canadian consumers already struggling with a tough housing market and heavy debt loads. But what might it mean for their southern neighbours?
With the Fed’s next meeting scheduled for September 20-21, analysts are already betting that Powell will follow in the footsteps of Bank of Canada Governor Tiff Macklem.
Here’s why central banks around the world are taking such drastic action — and what it means for consumers on both sides of the border.
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Little pain is the goal
Normally, the Bank of Canada aims to keep inflation at a modest 2%, just as the Federal Reserve does.
But with Canadian inflation hovering at 7.6% in July — just a hair below a 40-year high — the bank has had to use the big guns.
The nation’s central bank typically hammers its key interest rate to modest 0.25% increases, but Macklem announced on Sept. 7 that it would raise it by 0.75% — after a shocking full percentage point hike in July.
That brings the Canadian overnight rate to 3.25% — up from just 0.25% in January.
The effects of rising prices on consumers are immediate.
“Housing investment is already falling very fast, consumption of durable goods is falling rapidly,” notes Karyne Charbonneau, senior economist at CIBC. “So we’re already seeing the impact it’s having on consumers.”
“The higher it goes, the more painful it is for consumers. But that’s kind of the goal. That’s how you control inflation by stopping spending.”
Keeping the economy on track
Charbonneau stresses that rate hikes won’t last forever. Both the Bank of Canada and the Federal Reserve will seek to eventually return to a neutral interest rate—that is, an interest rate that does not stimulate or constrain the economy. Currently, the estimated neutral rate is 2.5%.
“Being at 3.25%, it would be in restrictive territory, which means at some point it has to go back to what they estimate is the neutral rate,” says Charbonneau.
But as for the timing, he says “it’s hard to predict exactly when that will be right now.”
Charbonneau points out that preemptive increases in the overnight rate are one way to accelerate the changes needed to reduce inflation. Another significant increase in interest rates will help you reach neutral territory faster.
He adds that the economy is already showing signs of slowing down.
However, for an economic course correction to be successful, higher interest rates will have to stay with us on both sides of the border for a while.
“It’s painful,” says Charbonneau, “but it’s part of the process. Otherwise, we will be in a much worse situation.”
How might this affect the Fed’s next announcement?
Like in the U.S., inflation in Canada is “down a bit, but still very high” — as Bank of Canada Governor Tiff Macklem wrote in an August article.
The most recently updated US inflation data showed July’s 8.5% inflation was down slightly from June’s 41-year high of 9.1%, which could mean the Fed is seeing some success in its strategy.
But a month of movement in the right direction is not enough to stop pushing, Powell said at a meeting in August, adding that it was not time to “pause” or “stop” inflation measures.
Powell reaffirmed his aggressive stance on fighting inflation in a Sept. 8 moderated discussion at the Cato Institute, a libertarian think tank in Washington.
“History strongly warns against premature easing of policy,” he said. “I can assure you that my colleagues and I are strongly committed to this project and will maintain it until the job is done.”
That same morning, investors priced in an 86 percent chance of a 75-basis-point hike at the Fed’s September meeting, according to the CME Fedwatch tool.
With the Fed’s overnight rate now sitting between 2.25% and 2.50%, with plans to raise it to at least 3.4% by the end of the year, another outsized hike is certain to be announced later this year month.
“The clock is ticking,” Powell said. “The longer this inflation remains well above target, the greater the concern that the public will naturally begin to incorporate higher inflation into their economic decision-making.”
“And our job is to make sure that doesn’t happen.”
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This article provides information only and should not be construed as advice. Provided without warranty of any kind.