Bank of Canada makes oversized rate hike, hints increases may be over

"While the tightening cycle likely has reached its zenith, we'll need the pain of these higher rates to persist for a while to stall economic growth and thereby cool inflation," said Avery Shenfeld, chief economist at CIBC Capital Markets. Money markets had bet on a 25-basis-point increase, but a slim majority of economists in a Reuters poll expected a 50-bps move.

The Bank of Canada on Wednesday hiked its benchmark overnight interest rate by 50 basis points to the highest level in almost 15 years and signaled its historic tightening campaign was near an end. The central bank has raised rates at a record pace of 400 basis points in nine months to 4.25% - a level last seen in January 2008 - to fight inflation that is far above its target. The bank cited still-strong growth and tight labor markets as the reason for the latest increase.

But it eliminated the forward guidance it has used since it began cranking rates higher in March, dropping language that said they would have to rise further. "While the tightening cycle likely has reached its zenith, we'll need the pain of these higher rates to persist for a while to stall economic growth and thereby cool inflation," said Avery Shenfeld, chief economist at CIBC Capital Markets.

Money markets had bet on a 25-basis-point increase, but a slim majority of economists in a Reuters poll expected a 50-bps move. Gross domestic product growth in the third quarter, which grew at an annualized 2.9%, was stronger than expected and there is still "excess demand" in the economy, while labor markets remained tight, it said.

Overall, however, the central bank said that data supported its October forecast that growth would stall through the middle of next year. "Looking ahead, Governing Council will be considering whether the policy interest rate needs to rise further to bring supply and demand back into balance and return inflation to target," the bank said in a statement.

Inflation, which clocked in at 6.9% in October, "is still too high", but three-month rates of change in core inflation have declined and indicate "prices pressures may be losing momentum," the bank said. "They continued to worry about inflation becoming entrenched and that's what this rate hike (is) really about," Royce Mendes, head of macro strategy at Desjardins Group, said in a research note.

If the bank's tightening campaign overshoots, it could trigger a deeper downturn than expected, something that the bond market is now signaling is a risk. The Canadian dollar was trading 0.3% higher at 1.3614 to the greenback, or 73.45 U.S. cents, after earlier touching a one-month low at 1.3699.

(Additional reporting by Fergal Smith in Toronto, Editing by Sandra Maler, Kirsten Donovan and Deepa Babington)

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