Deputy Bank of Canada governor warns key interest rate could rise above previous target of 3 per cent

One day after raising the key interest rate by 50 basis points to 1.5 per cent, the Bank of Canada is warning Canadians that rates could rise above previously targeted levels in order to deal with what the bank calls “entrenched inflation.”

“We must raise interest rates, both to bring demand in line with supply and to ensure entrenched inflation cannot take hold,” said deputy Bank of Canada governor Paul Beaudry, in a speech to the Gatineau Chamber of Commerce.

The bank had previously targeted raising the key overnight lending rate to between 2 per cent and 3 per cent in order to tame inflation but with Canada’s economy currently “overheating,” the bank now believes the rates might need to exceed the previous targets.

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“We may need to raise the policy rate to the top end or above the neutral range to bring demand and supply into balance and keep inflation expectations well anchored,” said Beaudry.

A neutral interest rate is where the bank believes rates neither stimulate nor weigh on growth of the economy.

Future rate hikes would help combat what Beaudry calls “entrenched inflation,” a scenario where prices rise because other prices are rising and because the cost of labour is going up. In that scenario, the bank believes inflation would become “self-fulfilling” and continue to increase.

“History shows that once high inflation is entrenched, bringing it back down without severely hampering the economy is hard,” said Beaudry. “Preventing high inflation from becoming entrenched is much more desirable than trying to quash it once it has.”

Beaudry acknowledges that some feel that entrenched inflation is already happening, but the bank believes that outside factors like war in Ukraine, supply chain shortages and COVID lockdowns in China are still playing a large role in inflation sitting at a 31-year high.

The deputy governor also admitted that not only has inflation not met the bank’s 2 per cent target but inflation has “consistently exceeded (the bank’s) forecasts.” Beaudry promised an analysis of why the bank has made forecasting errors on inflation at their next update in July.