These days, inflation is the talk of the town -- and justifiably so. Inflation in Canada is currently at its highest level in almost four decades, and with more policy interest rate hikes to come, there is little relief in sight. 

In a new update, Chief Economist at Canada Mortgage and Housing Corporation (CMHC) Bob Dugan hashes out two interest rate scenarios -- one that considers a moderate interest rate increase to 2.5%, and another detailing a more drastic interest rate spike to 3.5%.

With both scenarios, the idea is that inflation would sink to a healthy 2% by the end of 2023. But that's only a piece of the bigger picture. Although both scenarios would ensue an economic downturn in some capacity, the high interest rate scenario could result in a mild recession by the end of this year. 

If the Bank of Canada increases its benchmark interest rate to 3.5% in 2023, it will curb consumer growth, the national average home price will likely decline by 5%, national home sales will likely fall by 34%, and the unemployment rate will rise to 7%. The recessionary effects would persist for two quarters.

Conversely, if the Bank opts for a more neutral policy rate of 2.5%, and keeps the rate at a moderate level from 2023 to 2025, the national average home price will likely decline by 3% and national home sales by 29%. Unemployment will still rise, but certainly not to 7%.

The ongoing irony is that the Canadian economy has rebounded nicely from the pandemic. The country is showing strong economic growth, strong job creation, and a record-low unemployment rate of 4.9%.

But the current trajectory is simply not sustainable and interest rate hikes are the Bank's solution for containing inflation. Although there is debate on whether this is the best method for bringing inflation down, it is certainly the status quo. Moreover, this is the third time that the Bank has raised its policy interest rate (a total of 125 basis points), from March to June 2022, indicating that it tends to favour aggressive hikes over moderate ones. 

In other words, brace yourselves. Recession or not, things are about to get tense. 

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