The Bank of Canada’s primary objective is to preserve the value of money by keeping inflation low, stable, and predictable.

To this end, the central bank uses an inflation-control target based on the consumer price index (CPI) to achieve its mandate.

Interest rates are key policy tools for the Bank of Canada (BoC) to control the country’s money supply and influence the rate of inflation. More specifically, the bank’s policymakers attempt to adjust interest rates over time so that the CPI rises an average of 2% annually over the medium term.

At its recent meeting, the BoC once again chose to keep its benchmark overnight rate at 0.5%, which is where it’s been since mid-2015. At the current level, the bank’s short-term rate is just a quarter-point above where it bottomed during the Global Financial Crisis.

The BoC defended its decision to stand pat by stating that “… it is too early to conclude that the economy is on a sustainable growth path.”

At the same time, the bank also boosted its forecast for full-year 2017 gross domestic product (GDP) growth to 2.6% from 2.1%. The new estimate is especially noteworthy because it’s slightly above the 2.5% threshold that the bank previously identified as the point at which the economy would be firing on all cylinders.  

Recent economic data have been strong, and first-quarter GDP is expected to grow more than 3%. Job creation has also been on a tear, tracking well above the normal monthly average.

Meanwhile, inflation has picked up sharply in recent months. The overall CPI increased 2.1% year over year in January, while core inflation, which excludes volatile food and energy prices, was up 1.7%. Although these readings are still within the bank’s targeted inflation range of 1% to 3%, the CPI is finally moving up again after a sustained period of softness.

Beyond that, asset inflation, which does not feature directly in the inflation measures preferred by the bank, has been out of control for some time. For instance, housing prices in Vancouver and Toronto have jumped 38% and 47%, respectively, over the past three years.

Additionally, inflation is running well ahead of the bank’s policy rate, resulting in a deeply negative real rate of interest. Money that is too cheap for too long creates distortions in the financial and real economy.   

The question is whether market and economic developments are going to force the BoC to move away from its neutral position and start to prepare markets for higher rates.

We would argue that economic conditions in Canada are vastly different from the crisis conditions of 2008-09. Indeed, the Canadian economy is actually performing better than the U.S. economy according to a number of key metrics, including GDP growth and job creation.

With inflation accelerating and asset inflation in runaway mode, crisis-level interest rates are no longer applicable. Consequently, we expect interest rates in Canada will rise sooner than what most analysts and investors are expecting.