Brace yourself: Interest rates could be headed up even faster and higher than we thought

When the Bank of Canada raised its benchmark interest rate for the first time in two years earlier this month, it sent an unmistakable message to borrowers that the era of cheap money was coming to an end.

While economists expect the bank to gradually raise its rate another half-dozen times or so this year, there's a growing sense that the bank may need to start moving faster and more dramatically than anticipated to rein in inflation, which is already at its highest level in a generation.

Pricing in investments known as swaps suggests there a good chance the bank will ratchet its rate up by half a percentage point when it meets in April, taking the benchmark rate to 1 per cent.

At central banks, caution is a virtue, so they tend to like to move up and down slowly, in 25-point increments, or a quarter of a percentage point at a time. Moving half a percentage point at a time is a sign the bank could be thinking more aggressive action is necessary.

The bank's deputy governor said as much at a speech in San Francisco this week, telling attendees at a monetary policy conference that an uptick of household debt was "worrisome" and that the bank was "prepared to act forcefully" to ensure inflation doesn't run too hot for too long.

"I expect the pace and magnitude of interest rate increases ... to be active parts of our deliberations at our next decision," Sharon Kozicki said.

For Carlos Capistrán, an economist with Bank of America, strong language like that from a central banker is a clear sign that "everything is on the table," when it comes to bringing down inflation.

That type of tough talk is the banks' way of saying "We're really going to fight this forcefully if we need to," according to Capistrán.

It's why he's hiked up his rate forecast since Kozicki's speech, to include not just one but three big hikes in quick succession. He's now projecting the central bank to hike by 50 points at each of its next three meetings in April, June and July, and follow those up with smaller ones after that into next year until the bank rate sits at 3.25 per cent.

That's almost double the 1.75 per cent the bank's rate was at before the pandemic, and you'd have to go back to 2008, before the financial crisis, to find the last time the rate was that high.

To Capistrán, the reasons to speed things up are obvious. "Inflation is pretty high, the economy is really hot, the labour market is really hot in Canada and the [U.S.] Fed is about to hike 50 basis points as well," he said in an interview. "So there are a lot of reasons why they may be more aggressive than usual this time around."

Aggression may be what's required right now, but borrowers risk being the collateral damage in the central bank's nascent inflationary fight.

Variable rate loans are pegged to the central bank's rate, and they've been inching higher in recent weeks, in anticipation of the bank's move.

Fixed-rate loans, meanwhile, aren't impacted by the central bank's rate and are instead priced based on what's happening in the bond market, but there, too, the market has been flashing red warning signs for the past month: rates are headed higher, fast.