The Deputy Chief Economist at HSBC, Ben Tal, confirmed that the mission of the Canadian bank now is to manage the "size of the excess."

Moreover, the Bank of Canada has now raised the key lending rate by 475 basis points, or 4.75 percentage points, since last March, marking the fastest pace of increases in Canadian history.

In a recent research note, Tal states, "The bank chose to err on the side of many increases rather than too few for one simple reason: its bias toward combating inflation."

Tal further explains that the Bank of Canada faces two options: continued high inflation if interest rates fail to quell excess demand in the economy, or recession if interest rates rise and end up reversing economic growth, as the Bank of Canada surpasses its limits by raising interest rates.

Tal added, "The bank will face a recession any day now, as central banks have many tools and great experience in dealing with recessions. On the other hand, out-of-control inflation expectations are the worst nightmare for central bank governors."

At this stage of the interest rate hike cycle, Tal sees that for every positive economic indicator pointing to economic strength, there is another equally negative or downturn indicator, but given the bank's bias, greater weight is given to strong indicators.

One example of this is the bank's recently updated GDP growth forecasts, in the latest monetary policy report, where it was stated that GDP is expected to grow by 1.8% in 2023 year-on-year (up from previous expectations of 1.4%).

However, Tal states that the revised forecasts are strategic positioning and will limit the need for the bank to react to any strong indicators.

Similarly, the bank's revised forecasts for Consumer Price Index inflation will return to its 2% target by mid-2025, which is simply a process of buying time with limited risks of raising long-term inflation expectations.

Tal emphasizes, "This is a good plan, as buying time will allow the bank to be less reactive to current/short-term strong numbers while giving time for some important forces to lower inflation."

These disinflationary forces include improvements in supply chain conditions, which have an effect on reducing the overall margins for retailers, which Tal calls "the underestimated disinflationary force on both sides of the border."

He also points out that the labor market may not be as tight as it seems due to the undervaluation of the labor supply through the "huge undercount" of non-permanent residents in Statistics Canada's employment data.

The big question remains whether we have seen the peak of interest rates from the Bank of Canada or if there is another increase on the horizon.

Markets still overwhelmingly expect another quarter-point rate hike at the bank's next policy meeting on September 6, with current odds of 80%.

Tal indicates that the bank may continue to delve deeper into the "excess" area, but adds that the effects of past interest rate hikes will soon be felt more broadly.

Tal wrote, "The Bank of Canada may raise rates again in September, but soon enough the current inflation forces will be so significant that they cannot be ignored, even for a biased bank."