The amount of underlying inflation is likely to be a stronger indicator than the central bank's highly scrutinized estimate of the neutral interest rate as investors consider how much further the Bank of Canada will tighten. The benchmark interest rate for Canada was increased last week to 3.25%, a 14-year high and the highest policy rate among the ten central banks in charge of the most traded currencies. The policy rate remained above the 2% to 3% range that the central bank considers a neutral setting or the point at which monetary policy neither stimulates nor restrains the economy.
The BoC and investors had anticipated that an increase in interest rates would eventually reach a point above the neutral rate. The real neutral rate + two percentage points for inflation is how the BoC calculates the neutral rate. The issue is that inflation no longer approaches 2% outside of Canada. Consumer price inflation increased significantly this year, 2022, compared to the last year, 2021, according to GlobalData.
According to some Federal Reserve officials, the neutral rate for the United States may be higher than anticipated in the current climate. According to US consumer price statistics, investor expectations of a reduction in price pressure were dashed on September 14, 2022. The Bank of Canada has acknowledged the drawbacks of the neutral notion in the interim. The BoC's preferred core inflation gauges were all at or above 5% in July, whereas Canada's headline inflation rate was 7.6%. According to the central bank's most recent prediction, released in July, inflation will exceed its 2% objective until the end of 2024.
Financial markets anticipate that the BoC will raise interest rates by another three-quarter of a percentage point over the upcoming months, seemingly in agreement with the necessity for more stringent policies.
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