OTTAWA — The Bank of Canada hiked its key interest rate by a full percentage point Wednesday in the face of inflation that’s again “higher and more persistent” than it previously predicted. Many analysts had been expecting an increase of three quarters of a point and thought that would have been aggressive.

This is the biggest single increase since August 1998, when the central bank was rushing to prop up the Canadian dollar’s value amid a financial shock in Asia.

The hike puts the central bank’s overnight rate at 2.5 per cent. It was just 0.25 per cent at the beginning of March, when the Bank of Canada started shifting from shielding the economy against shocks from COVID-19.

Why: The bank now predicts that inflation will be about eight per cent for at least the next few months, four times its target rate of two per cent.

Supply-chain problems and Russia’s invasion of Ukraine are still factors contributing to shortages of goods and more expensive inputs, it said, but “domestic demand pressures are becoming more prominent and price pressures have broadened. … With strong demand for their products, businesses are passing through higher input and labour costs to consumer prices.”

In other words, inflation is getting more out of hand and Canadians are beginning to expect it to stick around. When that happens, inflation gets even harder to control. The bank’s governing council believes it needs to stomp the problem, now, with both feet.

Inflation eats away at savings and purchasing power and makes people’s financial futures uncertain. The bank aims for an inflation rate that’s not just low but predictable.

What the bank thinks this will do: Smash the inflation monster. If it’s even more expensive to borrow money to spend or invest, housing prices will decline, energy prices will decline, consumers will pull back on spending and the supply of the goods they want will normalize.

According to its new predictions, “domestic price pressures are expected to abate, global supply-chain problems are anticipated to resolve gradually, and energy prices are projected to decline.” Inflation will decline to “roughly three per cent” by the end of 2023 (the top end of the central bank’s comfort zone) and “return to the two per cent target by the end of 2024.”

The rate hike will hurt some people, the bank’s governor, Tiff Macklem, said in a news conference. “We know that higher interest rates will add to the difficulties that Canadians are already facing with high inflation,” he said. “But the strain of higher interest rates in the short term will bring inflation down for the long term. It will get us to the other side of this difficult period and back to normal.”

Macklem said the bank expects economic growth of 3.5 per cent this year, 1.75 per cent next year and 2.5 per cent in 2024. In other words, it doesn’t see a recession on the horizon, despite all of the economic turbulence.

“This is the soft landing we are projecting,” he said. “But the path to this soft landing has narrowed because elevated inflation is proving more persistent.”

How wrong the central bank has been: The Bank of Canada revises its overnight rate eight times a year and produces a detailed report on its decisions every second revision. Since the last report in April, the bank said today, it’s decided it was too low by almost two points in its inflation prediction for 2022, by 1.8 points for 2023 and 0.2 points for 2024.

Why it was wrong: The new report includes an appendix picking over its forecasting errors. It says the Bank of Canada, “like other central banks, has underpredicted inflation since spring 2021.” Oil prices are a big factor; the bank assumes they’ll stay flat, and they haven’t. Furthermore, high oil prices usually translate into a higher Canadian dollar, which hasn’t happened in the pandemic recovery. Higher commodity prices explain about 45 per cent of the bank’s error, in its self-evaluation.

Other important factors: U.S. demand for consumer goods has been higher than the bank predicted, meaning more money chasing the same limited supply of stuff. And the Canadian economy’s recovery has been stronger than expected.

What could go wrong now: The bank could be wrong again. If higher inflation persists and it’s not expected to come down, the self-fulfilling prophecy effect will kick in. If that happens, “a greater degree of monetary policy tightening” (that is, even higher interest rates) “and a more pronounced slowdown of the economy would be needed to bring inflation back to target,” the bank said.

Alternatively, if the general global economic slowdown the bank is predicting is worse than expected, the higher interest rates will be more painful than the bank thinks is necessary.

What happens next: Although the central bank’s governing council decided to “front-load the path to higher interest rates,” it still expects to increase them further. The next interest-rate decision is scheduled for Sept. 7.