OTTAWA — The Bank of Canada is moving hard to try to squelch inflation, laying out its reasons in a quarterly report on the state of the economy.

Here’s what you need to know:

The big move: After edging its key interest rate upward by a quarter-point in March, the central bank is hiking the rate another half-point, to one per cent. Before those increases, the “overnight rate” for very short-term loans to major banks was as low as the bank believed it could go, 0.25 per cent.

The Bank of Canada is also beginning quantitative tightening April 25, starting to reduce its holdings of federal government bonds. When the COVID-19 pandemic hit, the bank went on a buying spree of government bonds, to make sure credit markets didn’t lock up. It’s previously signalled its willingness to keep buying government bonds was over, but now it’s going to move in the opposite direction, letting its balance sheet shrink as those bonds mature and expire.

The bank expects about 40 per cent of those bonds to leave its books over the next two years.

The higher interest rate and shrinking of the overall money supply are meant to reduce demand by leaving less cash in the economy and making borrowing more expensive.

“The economy can handle higher interest rates, and they are needed,” the bank’s governor, Tiff Macklem, said in a news conference.

The forecasts: The Bank of Canada’s target for inflation is about two per cent over time—some months a little higher, some months a little lower.

Its outlook on the Canadian economy has changed since it tried to see into the future last October, when it said that “the recent increases in inflation experienced in some countries are driven mostly by transitory factors that are boosting the level of prices.”

What happened: Inflation in Canada is higher than the bank expected. Much higher. After projecting that a brief inflation bubble in late 2021 (puffed up by restoration of normal economic activity after pandemic lockdowns and supply-chain snarls) would pop, the bank now says that it’s continuing to grow: “Inflation is expected to average just below six per cent through the first half of 2022 and remain well above the control range through the rest of the year.”

The bank’s latest take on the global economy is that it’s ticking along, but Russia’s invasion of Ukraine has “pushed commodity prices higher and further disrupted supply chains.” (The effects from the war in Ukraine account for about 0.7 percentage points of inflation in Canada, the bank says.) Consumers in most of the world, including Canada, are ready and willing to spend, but the things they want to buy are not readily available.

Since COVID-19 emerged, Macklem said, “We’ve experienced the sharpest decline in our economy. We’ve also experienced the fastest rebound, and with that, global supply chains have not been able to keep up.”

Labour market conditions are tight, so workers are demanding higher pay, which means they can afford to pay more for goods and services, and around and around we go.

This is happening all over, the Bank of Canada emphasizes, with even higher inflation in the United States and Europe.

The bank’s big worry: A lot of what the Bank of Canada does is try to reassure people that overall, inflation will be close to the two per cent target because expectations are a big part of an inflationary spiral. If individuals and businesses expect prices to rise, they try to get ahead of it, demanding higher wages, hiking prices, buying up goods and supplies at what will later look like bargain prices.

This creates the very effects they’re trying to avoid, which messes up the bank’s attempts to be reassuring, and that is just what’s beginning to happen.

“While long-term expectations remain anchored on the target, near-term expectations have risen along with inflation,” the bank’s report says.

Something has to be done, Macklem said: “We are committed to using our policy interest rate to return inflation to target and will do so forcefully if needed.”

This could be unpleasant for Canadians facing higher mortgage rates and other increased borrowing costs, he said. But the bank believes higher prices across the whole economy are harmful, too.

Uncertainty, everywhere: Many scenarios could upset the central bank’s projections. The odds of being off in either direction are about equal, but “the upside risks are of greater concern because inflation is very high.” The things that could have the biggest effects, according to the central bank, are:

• More supply-chain problems, driven by China’s COVID-19 lockdowns or the war in Europe. Businesses could re-set their supply chains to draw on predictable, but more expensive, sources. Result: Inflation ⬆️.

• Stronger household spending. If Canadians get really excited about the end of the pandemic, we might see a rerun of the Roaring ‘20s. Result: Inflation ⬆️.

• Quicker-than-expected supply-chain fixes or reduced demand. Maybe China controls COVID-19, shipping smooths out, Russia’s army goes home, consumers get less excited. Result: Inflation ⬇️.

• Sharp deterioration in global finances. Lenders’ appetite for risk could fail at the same time as governments’ pandemic programs wrap. China’s real-estate troubles could spill over. Result: Inflation ⬇️.

What’s next: The bank’s next interest-rate announcement is June 1 and it says “interest rates will need to rise further [and] quantitative tightening will complement increases in the policy rate.”

Macklem said a normal interest rate for the bank is between two and three per cent, and that’s roughly where things are headed. But “how high rates will go will depend on how the economy responds and how the outlook for inflation evolves.”

In short, if you need to borrow money, the Bank of Canada is saying borrowing will be cheaper now than it will be in two months.