Bank of Canada hikes interest rate to 2.5% — biggest jump since 1998

The Bank of Canada has raised its benchmark interest rate by the largest amount in more than 20 years, sharply increasing the cost of borrowing in an attempt to rein in runaway inflation.

Canada's central bank raised its benchmark interest rate Wednesday by a full percentage point to 2.5 per cent. That's the biggest one-time increase in the bank's rate since 1998.

The bank's rate impacts the rate that Canadians get from their lenders on things like mortgages and lines of credit.

All things being equal, a central bank cuts the lending rate when it wants to stimulate the economy by encouraging people to borrow and invest. It raises rates when it wants to cool down an overheated economy.

After slashing its rate to record lows at the start of the pandemic, the bank has now raised its rate four times since March as part of an aggressive campaign to fight inflation, which has risen to its highest level in 40 years. 

Economists had been expecting the bank to raise its rate by three-quarters of a percentage point, but the full percentage point increase was ahead of even those high expectations.

"With the economy clearly in excess demand, inflation high and broadening, and more businesses and consumers expecting high inflation to persist for longer, the Governing Council decided to front-load the path to higher interest rates by raising the policy rate by 100 basis points today," the bank said.

The bank made it clear that even more rate hikes are in the offing in the coming months, too.

"The Governing Council continues to judge that interest rates will need to rise further, and the pace of increases will be guided by the Bank's ongoing assessment of the economy and inflation."

The impact of higher rates will be felt most directly on the housing market, as variable rate mortgages are closely tied to the central bank's rate.

Canada's housing market was red hot for most of the pandemic, as record low rates fuelled demand and pushed prices up to their highest levels ever. But that direction turned in the first part of this year, as the central bank's signal that higher rates were coming took the wind out of the sails of insatiable demand. 

Average prices have fallen since March across the country, the Canadian Real Estate Association says. Wednesday's rate hike will do nothing to reverse that trend.

Existing owners on variable rate loans, and those looking to buy, will likely notice their mortgage rates go up almost immediately. 

The hike is exactly what home owner Tim Capes was worried about last month when he switched his home loan from a variable rate to a fixed term.