Good Morning!
It’s the Bank of Canada’s decision day on Wednesday and the pundits see little chance of anything but a hold on interest rates.
In fact, markets have priced in the probability of the central bank making a ninth hike this week at effectively zero.
When the Bank last raised rates in January it said if the economy unfolds as expected it would hold its rate while it assesses the impact of hikes so far.
Since then there have been signs the economy has slowed even more than the Bank expected. January’s inflation rate came in at 5.9 per cent, a significant decline from 6.3 per cent the month before, and the economy recorded no growth in the fourth quarter.
So a hold this week looks almost certain, but some economists argue that it is too soon to say interest rates in this country have hit their peak.
One big concern is divergence with the United States Federal Reserve.
The Bank of Canada is limited in how much its interest rate increases can lag the Fed’s, as the gap could weaken the Canadian dollar and fuel inflation, said Derek Holt, head of Scotiabank’s capital markets economics, in a note.
Money markets are betting that chairman Jerome Powell will raise the Fed funds rate to between 5.25 per cent and 5.5 per cent, and that would test the Bank of Canada’s resolve, said economists in a Bloomberg survey.
And traders in overnight swaps are betting the Bank of Canada will eventually deliver another 25 basis-point hike at some point this year, says Bloomberg.
“Canada does not need more hikes to cool inflation, although they may be forced to hike if the gap in policy rates starts to cause major currency weakness,” said BofA global economist Ethan Harris.
Capital Economics’ Stephen Brown thinks the Bank of Canada, while holding on March 8, will continue to stress its readiness to resume hikes if needed.
“If the Bank were to send a dovish message [this] week, it would risk a sharper exchange rate depreciation that would increase the upside risks to imported goods inflation,” wrote Brown.
The loonie was trading at 73.42 this morning.
While acknowledging that a growing policy rate differential would not be supportive of the Canadian dollar, National Bank economists disagree that this will force governor Tiff Macklem’s hand.
The Bank of Canada last May expressed concerns about the currency, but back then prices pressures were at their peak, they said.
Since then the Bank has downplayed those fears, with deputy-governor Paul Beaudry saying in a speech last month: “We shouldn’t be too concerned if Canada follows a slightly different path to normalization than our counterparts.”
A wide interest rate gap “might not be good news for the C$ but, as long as inflation moderation continues we think the Bank will (rightly) prioritize not crushing the Canadian economy under the weight of even higher rates,” said National.
