In this week’s episode of Make Money Count, Marcus and Justin take on the question on every borrower’s mind after the Bank of Canada’s rate hike: how does raising rates fix a problem that starts with the price of oil? Here’s how they break down the Bank’s reasoning, and why Marcus calls it the most important explanation to come out of the press conference.

What the Bank Did

The Bank of Canada raised the overnight rate by 25 basis points, from 2.25% to 2.5%. That pushes prime up 25 basis points, and variable rates move with it. If you have an adjustable payment, it increases. If your payment is fixed, it stays the same, but less of it goes toward principal.

The Question Behind the Hike

At the press conference, a reporter asked how raising rates could do anything about the higher price of oil. Justin had asked the same thing in the previous episode. Marcus’s answer is simple: increasing the cost of money does not decrease the cost of fuel. Rates can’t touch the price of oil, so the Bank has to look at what happens after it rises.

Oil Is the Spark, Demand Is the Fuel

Marcus points to a Bank of Canada survey showing that businesses have started, or are about to start, passing higher oil costs on to consumers. Once that happens, inflation becomes more entrenched. His analogy is that oil is the spark, and the Bank needs to contain the fire. Businesses can only raise prices if consumers keep spending, so the Bank raises the cost of money to tamp down demand. With less demand, businesses have a harder time raising prices, and the economy settles at a new balance. Marcus is clear that this causes pain for consumers, and that creating it is the intent.

Why Expectations Matter

Marcus highlights two data points the Bank watches closely. The first is the business survey on passing on costs, which came back bad. The second is consumer expectations on inflation, which also came back bad. If consumers believe inflation is here to stay, they push for higher wages, which pushes prices up again. Marcus calls it a self-fulfilling prophecy. By creating pain now, the Bank is trying to reset those expectations before they take hold.

A Stronger Dollar Helps Too

Marcus adds that higher rates firm up the Canadian dollar. That makes imported goods and services a little cheaper, which gives the Bank another way to cool inflation.

Could Government Relief Change Things?

A reporter asked why the Bank doesn’t leave fuel prices to rebates or tax cuts instead. The Governor’s answer was that it’s the government’s call, and the Bank will factor in whatever it decides. Marcus notes that fuel tax relief has already been introduced. In his view, the only thing that would stop the Bank from hiking is the federal government subsidizing fuel enough to bring the effective price of oil back down, which would mean giving up a large amount of revenue.

What Comes Next

The Governor and Deputy Governor repeated several times that the Bank is not on a charted course and has not decided on another hike. The Bank puts its neutral range at 2.25% to 3.25%, and Marcus notes that range can shift with the strength of the economy. The Monetary Policy Report also projects housing growth of about 1% over the next two years, which is essentially flat.

What This Episode Is Really About

The Bank sees runaway inflation as a bigger risk than the pain of a rate hike, and Marcus agrees that is the logic behind the move. A hike isn’t aimed at oil. It’s aimed at demand, so businesses can’t keep passing costs along and consumers don’t start to expect higher prices.

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