Despite hiking interest rates over the past several months, the Bank of Canada is now thinking of opting for restraint rather than aggression when implementing rate hikes. The Canadian central bank recently came to the conclusion that the economy is considerably more overheated than expected, and tightening measures could trigger an even deeper downturn in the near future.

The state of the country’s bond market is the prime indicator that the Canadian economy is in a difficult place. Ten-year government bond yields dropped by almost 100 basis points under the two-year yield in what is said to be the biggest inversion of the Canadian yield curve in nearly 30 years and went even deeper than the US Treasury’s current inversion.

Why is This a Point of Concern?

While most people remain focused on monitoring inflation, some analysts pay closer attention to curve inversions as a way of predicting an economic recession.

In this case, the Canadian economy is bound to feel the impact of higher rates, given how citizens borrowed extensively to purchase homes throughout much of the pandemic.

Corpay chief market strategist Karl Schamotta opines that the impact on the economy will be three-fold due to a general decline in domestic consumption, weakening demand in the United States, and the steady fall of commodity prices across the globe.

Currently, most money markets have bet on an increase of around 25 basis points when Bank of Canada executives meet on Wednesday, December 7, to set new policies. However, a marginally greater number believe that the increase may be significantly higher.

Recently, the central bank has been open to slowing down the pace of its rate increase to just a quarter of a percentage point after several large-scale hikes over the past several months. This resulted in the benchmark rate hitting its highest in nearly twenty years, settling at 3.75%.

Stronger Than Expected

But it has not been all bad news for Canada’s economy. While the country’s job market remains tight, around 10,100 new positions were added to it last month, and the overall unemployment rate fell to 5.1%, lower than the expected 5.3%.

Also, the country’s gross domestic product grew at an annualized rate of 2.9% by the end of Q3-2022, much stronger than the 1.5% pace previously predicted by analysts at the Bank of Canada.

Nevertheless, the central bank is sticking to its forecast that economic growth would slow down considerably during the fourth quarter and well into 2023.