Rate expectations: What’s the neutral rate, and why did the Bank of Canada raise it?

The Bank of Canada's interest rate decision on Wednesday didn’t bring cuts, but it did bring new insight into where the central bank thinks interest rates may be headed.

It's essentially the"Goldilocks" interest rate, explained Sheila Block, an economist and research associate with the Canadian Centre for Policy Alternatives. It's where the economy can keep growing, but inflation won't get out of hand. "Central banks are trying to reach this sweet spot where their rate decisions aren't causing a recession, and they're similarly ... not fuelling inflation," she said.

Bank of Canada governor Tiff Macklem said during a press conference Wednesday that the neutral interest rate doesn't have a big impact on the bank's deliberations in real time. Canadians grew accustomed to low interest rates before the COVID-19 pandemic, said Block, but any hopes that rates would return to pre-pandemic levels after the central bank had quelled inflation were"dashed a long time ago."The longer-term economic environment is changing because of several factors that will necessitate a higher neutral interest rate, she said. These include increasing government debt and the demands on investment from climate change.

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