With interest rates now in restrictive territory and signs of economic weakness, the Bank of Canada is facing one of its most important decisions in this rate-hike cycle, according to some.
“Canadian monetary policymakers have a major decision to make [this] week,” wrote Royce Mendes, Managing Director and Head of Macros Strategy at Desjardins. “In fact, it will be the most crucial deliberation of this rate-hiking cycle so far.”
Following the release of September inflation data last week, markets swiftly shifted their expectations for a 75-bps rate hike at the Bank’s upcoming policy meeting on Wednesday.
Because of that, the Bank of Canada “could certainly walk through that door without ruffling too many market feathers,” Mendes said. “But the overall environment is much
more precarious now than it was at the time of the Bank’s previous meetings.”
On the size of the hike:
- “One presumes the Governing Council will be debating whether it’s time to scale back the pace of tightening, for a number of recent economic signposts have surely been unnerving. Earlier rate hikes are clearly working and the economic mood has soured meaningfully. Yet, we’ve seen and heard enough of late to anticipate another oversized tightening move. Expect the Bank to hike the overnight target rate 75 basis points to 4% [this] week. That would make 375 basis points of cumulative tightening via six consecutive decisions.” (National Bank of Canada)
- “…we believe the Bank of Canada will raise rates 75 basis points [this] week. But we wonder whether it should start spacing out its increases instead. Monetary policy works with significant lags, so using current data to guide decisions is dangerous and almost guarantees an overshoot.” (Desjardins)
On what happens after this meeting
- “If the BoC hikes 75bps [this] week, then they probably have a terminal rate in mind that is in the ballpark of what the FOMC has guided for theirs (4.5-5%). It’s hard to imagine that after a 75-bps hike they either stop or downshift to just a 25bps, and then perhaps done.” (Scotiabank)
- “We continue to expect higher inflation and interest rates to push Canada into a moderate recession in the first half of next year. That would put the central bank in a position to pause interest rate hikes by the end of 2022. And indeed, we expect the overnight rate to end the year at 4%. But risks to that assumption are still tilted to the upside, and are contingent on broader inflation trends showing further evidence of slowing.” (RBC)
- “…there is spreading economic pain and although inflation is likely to be sticky in the near term, we expect the BoC to slow to a 50-bps hike in December with perhaps a final 25-bps hike in early 2023…Once the core CPI starts recording month-on-month readings of 0.2% or 0.3%, down from the current 0.4%/0.5% monthly increases, we think the BoC will pause with a strong likelihood that it starts to unwind rate hikes in the second half of 2023 as recessionary pressures mount.” (ING Economics)
On what the BoC is expected to say
- “…even if it isn’t [this] week, the Bank of Canada will soon face the difficult task of changing its narrative and signalling a pause in this rate hike cycle, at a time when inflation is still very high…As for [this] week though, any change in narrative will be subtle, such as adding the word ‘likely’ between the ‘will’ and ‘rise further’ in its statement. The Bank has a couple more meetings to decide just how to make the larger change in narrative that will soon be required (we forecast that the January meeting will be the first with no interest rate hike)…” (CIBC)
On implications for the Canadian dollar
- “…Macklem is signalling a return to rate substitutes to CAD moves that, while perhaps debatable in terms of whether they should be thinking this way, nevertheless signals a reaction function that is willing to do more to offset currency weakness…if the BoC hikes by, say, 50-bps and the Fed hikes by 75-bps on November 2 as widely expected, then a negative rate differential would open up across policy rates. All else equal…that could mean further CAD weakness, especially in relation to what is priced, which would go against their messaging and look highly inconsistent.” (Derek Holt, Scotiabank)
The following are the latest interest rate and bond yield forecasts from the Big 6 banks, with any changes from their previous forecasts in parenthesis.
| Target Rate: Year-end ’22 |
Target Rate: Year-end ’23 |
Target Rate: Year-end ’24 |
5-Year BoC Bond Yield: Year-end ’22 |
5-Year BoC Bond Yield: Year-end ’23 |
|
| BMO | 4.00% (+25bps) | 4.00% (+25bps) | NA | 3.60% (+30bps) | 3.20% (+15bps) |
| CIBC | 4.25% (+50bps) | 4.25% (+50bps) | NA | NA | NA |
| NBC | 4.00% (+25bps) | 3.50% (+50bps) | NA | 3.55% (+30bps) | 2.95% (-10bps) |
| RBC | 4.00% | 4.00% (+256bps) | NA | 3.35% (+35bps) | 2.95% (+45bps) |
| Scotia | 4.25% (+50bps) | 4.00% (+25bps) | 3.00% | 3.90% (+45bps) | 3.55% (+40bps) |
| TD | 4.25% (+25bps) | 3.25% (-75bps) | NA | 3.70% (+25bps) | 2.55% |
Feature image: Photographer: Justin Tang/Bloomberg via Getty Images