The Bank of Canada Wednesday left its key overnight interest rate on hold at 4.50% as expected and raised its growth forecast for this year, while keeping the door open to further rate hikes if the economy and inflation remain heated. It was the second consecutive policy announcement that saw the bank keep the trend-setting rate unchanged.
Markets took the news in stride. Canada’s 2-year bond yield, which is sensitive to changes in monetary policy, was down about 5 basis points in late morning trading. But that was mostly just following a dip in the U.S. bond yield of the same tenure, following a U.S. inflation report today that was modestly tamer than the Street consensus. The Canadian dollar saw choppy trading throughout the morning and didn’t establish any sustainable push in either direction.
Interest rate probabilities, based on trading in swaps markets, are pricing in a 25 basis point cut in the Bank of Canada’s overnight rate by December - unchanged from prior to both the Bank of Canada’s interest rate announcement this morning and the U.S. inflation report. Just a week ago, 50 basis points worth of rate cuts had been priced into markets by the end of this year.
Here’s how money markets are pricing in further moves in the Bank of Canada overnight rate for this year as of 11 am ET. While the bank moves in quarter point increments, credit market implied rates fluctuate more fluidly and are constantly changing.
And here’s how economists and market strategists are reacting:
Avery Shenfeld, chief economist, CIBC World Markets
The Bank of Canada’s current motto is “don’t just do something, sit there,” and patience should indeed be a virtue in getting inflation down to target without inflicting more pain on the economy than necessary. By including a warning that a further hike could still be required if the economy remains too heated, they are still far from being in line with market hopes for a rate cut later this year, and consistent with our view that we’ll have to wait until 2024 to get any interest rate relief.
As widely expected, the Bank left the overnight rate at 4.5%, and if there was a theme in their statement and the Monetary Policy Report, it was to do as little tinkering as possible with the overall outlook. The inflation outlook was essentially unchanged with the CPI reaching the 2% target late next year, the neutral rate of interest remained at 2.5%, and Q1 growth was just enough to leave the output gap where it stood in Q4. ...
Despite an upside surprise in Q1 growth, the Bank remains hopeful that their desired slowdown is coming, citing expectations for a cooling internationally, and the lagged impacts of higher interest rates on Canadian households and business investment. So much of the upward revision in the 2023 growth outlook, with raised the pace to 1.4% from 1.0%, came from the better start to the year. Still, what’s encouraging is that the Bank doesn’t see an outright recession as necessary to get inflation back to target, only a slowing to “weak” but still-positive growth over the balance of the year. To get to the prior forecast for the level of real GDP, the Bank has trimmed its growth pace for 2024 by a half point to 1.3%, but that would include a pick-up on Q4/Q4 basis from what they expect over the rest of this year. ...
In the near term, our growth forecasts are not far off those of the Bank, and still not quite meeting the definition of a full-blown recession. The Bank’s messaging still has a hawkish tilt, despite its decision to leave interest rates on hold. The emphasis in the statement is on the cup being only half full when it comes to having the ingredients needed to meet its inflation targets. Labour markets are still too tight, wages gains are elevated, the economy is in excess demand, and while headline inflation has eased a lot, some of the underlying measures are inconsistent with a sustained 2% inflation rate. The interest rate decision notes that the committee is still judging whether policy is tight enough, not whether it is too tight. That needn’t indicate a lot of risk of an actual rate hike in June if, as we expect, the growth numbers decelerate in upcoming months. But the messaging might help the Bank by countering the recent downward drift in bond yields, which threatens to provide a premature easing in term borrowing costs across the economy.
David Rosenberg, founder of Rosenberg Research
With all the commentary and caveats, the Bank managed to leave the bond market and Canadian dollar unchanged. No reason for anyone to change their views here. Our view is that the Canadian economy, much like the U.S., is going to be cooling off very rapidly in coming quarters and that inflation will be surprising to the downside. If you ask me the most important takeaway here, it was the comment that the economy will be moving into an “excess supply” environment in the second half of the year. Even with a higher real GDP forecast for 2023 (due principally to an early-year bounce) and lower estimates for potential growth, there is no economic construct either on practical or theoretical grounds that will fail to cause inflation to decelerate — what the Bank is focused on is the speed of the deceleration, but we are convinced that the destination will come sooner, not later, and that means a bullish bent for the GoC bond market and a bearish bias for the loonie (all the more so if the IMF is prescient on its downbeat global macro call, with negative implications for commodity markets and Canada’s terms-of-trade). Demand growth of just +1.4% this year (was +1.0% prior) and +1.3% in 2024 (a big slice from +1.8% in the previous set of forecasts last January!) — no recession here but “stall speed” nonetheless — are hardly the ingredients for a cyclically-induced inflationary backdrop.
Derek Holt, head of Capital Markets Economics, Scotiabank
In my opinion, if the BoC really wants to counter market pricing for policy rate cuts then actions need to be substituted for warnings that nobody is listening to. Jawbone all you wish, but if the BoC is saying they are uncomfortable toward the easier conditions being priced in the front-end of the Canadian rates curve because it complicates its inflation fight well then the most effective way of addressing this would be to stop the talk and hike or else be dragged along for the ride. Merely wagging a finger puts its credibility at risk.
Alternatively, the soundest argument for leaning against cut pricing would be that 2% inflation won’t be achieved and time will tell. It is Governor Macklem’s perhaps misplaced conviction that it will be achieved that is driving cut pricing. You can’t have it both ways by forecasting a perfect landing on 2% while beseeching markets not to price cuts. ...
Always, always remember that the BoC’s track record at forecasting inflation is poor. .... Therefore, we should take its forecasts with a high dose of skepticism. The BoC almost always shows itself to be fully under control of inflation—even when it obviously isn’t—by showing a return to 2% inflation as if magically within a medium-term horizon. Maybe if you stopped showing that wishful thinking you wouldn’t have markets pricing rate cuts from restrictive levels above neutral. The BoC doesn’t get the fundamental inconsistency between warning against pricing rate cuts while forecasting 2% inflation and either markets are right or the BoC won’t durably achieve 2%.
Stephen Brown, deputy chief North America economist, Capital Economics
The Bank of Canada delivered mixed messages today, noting that it is more confident that inflation will decline in the next few months but less confident that inflation will return to 2% as quickly as it previously anticipated. Nonetheless, with the Bank’s forecasts for both GDP growth and inflation still looking too high to us, we continue to expect the Bank’s next move to be an interest rate cut. ...
On the face of it, the modest change to the language in the final paragraph of the statement seems somewhat hawkish, with the Bank dropping the previous reference that it expects to keep the policy rate on hold, and instead noting that it “continues to assess whether monetary policy is sufficiently restrictive to relieve price pressures and remains prepared to raise the policy rate further if needed”. This change is presumably a nod to the fact that the Bank has pushed back the timing of when it expects CPI inflation to reach 2%, to late 2025 from late 2024. We would not read too much into the change, however, as the Bank still forecasts inflation to be very close to 2% over the second half of 2024 and the rest of the policy statement was more dovish. While the Bank recognized that the Canadian and US economies both made stronger-than-expected starts to the year, it stressed that, following the issues in the banking sector, “US growth is expected to slow considerably in the coming months, with particular weakness in sectors that are important for Canadian exports”. That ultimately caused the Bank to downgrade its forecast for Canadian GDP growth in 2024 to 1.3%, from 1.8%, although it pushed up its forecast for this year to 1.4%, from 1.0%, due to the strong first quarter.
Meanwhile, the Bank trimmed its estimates for potential GDP growth in the coming years, but left its estimate of the neutral policy rate unchanged at between 2% and 3%. Despite lower potential GPD growth, the Bank still expects excess supply to open up in the second half of 2023 as GDP growth slows well below its full potential. We continue to see both GDP growth and core inflation slowing even faster than the Bank assumes, with a modest recession likely, leading us to think that the Bank will be ready to cut interest rates in October.
James Orlando, director & senior economist, TD Economics
The BoC held the line in today’s announcement. While it acknowledged that the economy is exhibiting cyclical strength as evidenced by strong employment gains and a bounce-back in consumer spending, it appears confident that growth is set to slow in the coming months. This slowdown, though delayed, has kept the faith that inflation will continue to decelerate, hitting 3% year-on-year this summer.
Over the last couple of weeks, the timing of rate cuts has been pushed out, with markets now expecting the first cut to occur in December (from September). This reflects the economy’s cyclical rebound, which will keep underlying cyclical inflationary pressures (supercore) elevated through this year. As the BoC acknowledged, this could make “getting inflation the rest of the way back to 2%” more difficult. Given this backdrop, we think the best policy for the BoC is to keep rates stable until cyclical inflation dynamics turn decisively lower.
Douglas Porter, chief economist, BMO Capital Markets
While there was little suspense surrounding today’s Statement, the Bank’s revised economic and inflation forecast had some wrinkles. Even with lighter-than-expected flat GDP growth in Q4, a solid start to 2023 has boosted this year’s growth estimate 4 ticks to 1.4% (we’re at 1.0%). The global growth backdrop is better than expected, though the Bank continues to look for a slowdown in the coming months (both globally and domestically), citing the lagged effects of rate hikes as well as the recent banking sector strains. Governor Macklem said in the press conference that the economy needs a period of cooler growth to corral inflation, although the Bank’s forecast does not include an outright recession. The BoC notes ongoing excess demand in Canada, and while Q1 GDP was above its forecast, it still expected growth to be “weak through the remainder of this year”. Earlier rate hikes are anticipated to have an increasing impact on the economy, with the MPR detailing mortgage renewal dynamics. In fact, a weaker consumer spending and export outlook has prompted a 5-tick downgrade in next year’s growth forecast to 1.3%, matching our call (but the Bank now has growth lower in 2024 than 2023). With consumption poised to cool meaningfully, this “implies the economy will move into excess supply in the second half of this year”. The latter is despite a cut to potential growth estimates, suggesting the BoC could eventually be open to easing if inflation slows below 3%
However, that’s a big “if”, and the BoC remains acutely concerned about inflation. Wages are again noted as rising faster than productivity, even as labour shortages are starting to ease. Headline inflation is still expected to fall to 3% around mid-year, and it shaved the year-end estimate by 1 tick to 2.5%, with a slow move to 2% by the end of 2024. Another mildly dovish remark: “Recent data is reinforcing Governing Council’s confidence that inflation will continue to decline in the next few months.” But that’s promptly offset by concern that getting “the rest of the way back to 2%” could be a challenge. ...
On fiscal policy, the Bank estimates that overall additional fiscal spending of $25 billion per year has been added since the January MPR (i.e., during this year’s Budget season). That works out to almost 0.9% of GDP, which is even north of our estimate, and simply drives home the point that generally generous budgets this year are working at cross purposes with the Bank’s restrictive policy—at the margin, further pushing back the day when the Bank can begin cutting rates. And another item keeping inflation pressures aloft, at least in the Bank’s view is “corporate pricing behaviour”, which is at least a small nod that wider margins have been one driver of inflation in the past year. ...
Bottom Line: The BoC is comfortably on hold for the time being with inflation slowing in line with its forecast. The Bank’s expectation that the economy will be in excess supply by the second half of the year opens the door a crack to potential easing later this year if inflation continues to slow, but there’s still a lot of wood to chop on that front. In fact, the Governor explicitly stated in the press conference that market pricing of rate cuts later this year isn’t the most likely scenario. We continue to expect the Bank to remain on hold until the end of 2023 before rate cuts begin in earnest in 2024.
Taylor Schleich, Warren Lovely & Jocelyn Paquet, economists with National Bank of Canada
The headline decision itself was pretty straightforward as the criteria for remaining sidelined (i.e., the economy evolving broadly as expected in January), was met. However, the key aspects of the statement are very much open to interpretation and one can spin this any number of ways. To us, the statement is dovish in the near-term (despite the pledge to raise rate further if needed) as the Bank highlights a quick and seemingly high conviction expectation that inflation will fall to the top of the control band by mid-year. They’ve also noted they expect a swing to excess supply in the second half of the year. This suggests the bar to any further hikes is quite high. At the same time, there were a number of signs that the Bank sees inflation pressures as somewhat sticky, admitting that getting price pressures all the way to 2% could prove challenging. This raises some questions as to whether the Bank, when it ultimately does lower rates, will be able to get back within their estimated 2-3% neutral range, or back to pre-COVID policy rates. This reluctance to return to pre-COVID rates of interest is reflected in our interest rate outlook which has the Bank pausing/ending its eventual rate cutting cycle at 3%. More near term, we do think that rate cuts are appropriate/likely before the year is out and don’t view the rate statement as being inconsistent with that. The catalyst for such a pivot is likely be a further deterioration in the economic and inflation outlook. Indeed, we still believe the Bank may be overestimating the path of price pressures. The same goes for the growth outlook which we see as evolving much slower than the MPR pencils in for 2023 and 2024.
Royce Mendes, managing director & head of macro strategy, Desjardins Securities
The policymakers view the evolution of the economy this year very much the same as we do. As households renew their mortgages, more income will be devoted to debt-service costs which will weigh on consumption and GDP. Also similar to our forecast, the Bank of Canada sees economic slack opening up in the second half of this year. By the end of the year, officials see inflation back down to 2.5%. Where we disagree is on the pace of adjustment. We see scope for more economic weakness and a faster return to 2% inflation than the latest projections from the central bank.
We continue to believe that the next move from the Bank of Canada will be a cut. As the lagged impacts of past monetary tightening make their way through the system, we see the economy weakening and inflation returning to the 2% target. At that point, central bankers won’t need to employ such restrictive policy. For now, though, officials will be in a holding pattern. Inflation has shown some signs of progress, but there’s still work to do and it could take the rest of the year to get it done.
Jay Zhao-Murray, FX Market Analyst, Monex Canada
The crux of the matter is that the Bank of Canada is still more concerned about upside risks to inflation, as Macklem made explicit during the presser. While the Governor discounted much of the latest evidence to maintain last quarter’s inflation projections, the reality is that price pressures and the factors which fuel them are stronger than the Bank is letting on. For now, assuming that the Bank’s view that global banking stresses are subsiding holds true, we think that the strong emphasis on “higher for longer” in the press conference should take greater precedence over the statement’s mention that rates could be raised, suggesting a continued pause for the June meeting at least. Clearly, the Bank is going to try to stick to this view until contradictory evidence is so overwhelming that it is forced to change its policy. Whether that change is a rate hike or a cut depends mostly on how the banking story develops. If it fades out, we would expect a probable resumption in the hiking cycle. But should the Bank’s downside risk of a credit tightening-driven global recession materialize, expect the mirror image of the start of the current hiking cycle: previous words will no longer matter, and a pivot to cuts could easily emerge.
Philip Petursson, chief investment strategist, IG Wealth Management
I took the BoC statement as confirmation that we have seen the end of the interest rate increases. What wasn’t as clear, which the market was hoping for, was a firmer comment on the next move being cuts. The statement was definitely not projecting cuts anytime soon by my view. The statement acknowledged some of the weakness in the US and potential weakness in Canada but the tone was still hawkish against inflation with the Bank holding an option for further rate increases.
The risk the bank is playing is holding rates high long enough to satisfy it that inflation will remain within target while hoping the economy holds up. It’s a game of chicken between the economy and inflation to see which one might back down first.
Lesley Marks, chief investment officer, Equities, Mackenzie Investments
The Bank of Canada statement had a new reference on whether monetary policy was sufficiently restrictive to relieve price pressures and restore price stability which may be perceived as hawkish. Although stronger than expected economic data makes it more challenging for the Bank of Canada to remain on hold, stress in the global banking sector is leading to tighter credit conditions and may in turn help do the work of the central bank if these conditions lead to headwinds for economic growth. The bank still expects the economy to slow through the remainder of this year, despite the upside surprise in the first quarter. And, inflation, although still above the bank’s 2% target is declining quickly towards this target rate, also allowing the bank to stay on hold. If the economy shows the expected signs of slowing and inflation tracks lower over the coming months, we believe that the outlook for the Bank of Canada is to remain on hold for now.